Samsung Q2 16E – Galaxy cycle.

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A classic cycle will drive earnings for a few more quarters.

• Another solid set of numbers point to a nice confluence of events that I suspect has very little to do with anything special about the Galaxy S7 or the Google ecosystem that runs on it.
• Samsung has guided Q2 16E revenue / EBIT to be KRW50tn / KRW8.1tn nicely ahead of consensus at KRW50.9tn / KRW7.38tn and RFM at KRW51.7tn / KRW5.42tn.
• It is clear that the handset business has once again surprised where it looks like margins have remained comfortably above the 10-12% long term average that I have been forecasting.
• This has been offset somewhat by weakness in Semiconductors dragged down by the flattening handset market but, because the handset business is so large, it has been able to hold its own.
• I think that Samsung is currently enjoying a replacement cycle which combined with its rapid and efficient action on its cost base is producing excellent results.
• I see the following factors affecting the handset business:
  • First: I do not think that iPhone users are switching to Android.
  • Instead those who currently own an S4 or an S5 are taking advantage of attractive pricing on a great product to replace their devices in much greater volumes than expected.
  • The fact that there is nothing particularly new or exciting from Apple has helped but this is really about high end Android users replacing their older devices.
  • This results in a classic product cycle where sales rally for a period of 6-12 months while users upgrade and then return to baseline.
  • This is exactly happened to Apple with the iPhone 6 and is now happening to Samsung with the S7, albeit to a lesser degree.
  • Second: The product cycle has led to Samsung shipping large numbers of the S7 has concentrated its volume into fewer numbers of models.
  • This always leads to better margins because components can be acquired in greater volumes and development only has to be done once.
  • Third: Samsung has been very efficient at cutting its cost base and has not needed to increase costs again meaningfully in the face of nothing particularly new or exciting from Apple
• When Samsung reported its surprising handset margin of 14% in Q1 2016A, I was worried that this was a blip but it is clear that this is a replacement cycle.
• Hence, I am now comfortable that Samsung is going to see a good 2016 on the back of this cycle and against the weak expectations set during the difficulties it experienced in 2015.
• The net result is that Samsung will return to a period of good earnings growth for a few more quarters and then settle down into something much more leisurely as the current cycle comes to an end.
• Samsung has seen a rally in its shares as this cycle has gotten underway and I think the shares can remain strong at least until the cycle ends.
• Hence, I still like Samsung along with Microsoft and Baidu.
• Long term I am looking at Apple and Facebook.
• I remain cautious on Alibaba, Twitter, Google and Amazon