SEC Expected to Record Highest-ever Quarterly Earnings in Q417
October 23, 2017
Samsung Electronics dependence on component business, which is sensitive to market conditions including semiconductor and displays, continues to grow. Samsung Electronics posted 62 trillion won (US$54.99 billion) in sales and 14.5 trillion won (US$12.86 billion) in operating profit in the third quarter, up 1.64 percent in sales and 3.06 percent in operating profit, respectively, from the previous quarterly record profit in the second quarter. The company is expected to record its highest-ever quarterly earnings in the fourth quarter once again. Samsung said, “The semiconductor market conditions has continued to be in good shape. So, the business showings of the display division will improve as the sales of smartphones using OLED panels have increased. The mobile business division is also expected to see its performance increase as the sales of the latest Galaxy Note 8 are reflected in earnest in the fourth quarter.” However, as we discussed last week, the company’s dependence on its component business is expanding. Nearly 11 trillion won (US$9.76 billion) out of 14.5 trillion won (US$12.86 billion) of the total operating profit in the third quarter will come from the semiconductor and display divisions alone. The figure accounts for 76 percent of the total. Samsung Electronics has seen its dependence on the device solutions (DS) business division, which is in charge of parts business, such as semiconductor and display, grow after 2013 when the company made the biggest-ever annual earnings. The operating profit ratio of the DS division to the total has increased from 27 percent in 2013 to over 50 percent in 2015 and 2016, and is highly likely to reach 70 percent this year. The sales ratio of the DS division went up by about 10 percent points from some 20 percent in 2013 to some 30 percent last year and is expected to take up nearly half of the total this year. Given a continuance of current conditions, Samsung Electronics’ performance will likely go down when the market conditions for memory semiconductors, which occupy most of its semiconductor business, gets worse. The price of memory semiconductors is expected to decrease, as not only Samsung Electronics but also its competitors will begin operation of their expanded plants in earnest from 2019. Samsung Electronics’ share in its main markets of smartphones and TVs has been already lagging behind China due to its competitors’ growth and the price of liquid-crystal displays (LCDs) is on the decrease because of Chinese influence in the display sector. Samsung Electronics Vice Chairman Kwon Oh-Hyun said on the 13th that he would resign as the company’s head of the DS Business and the Chief Executive Officer of Samsung Display and would not seek re-election as a member of the Board of Directors and the Chairman of the Board when his term ends in March, 2018, saying, “We are reporting record profits but they are the fruit of the previous decisions and investments. We cannot even consider seeking out our new growth engine by reading the future trend.” “When a company makes late investment decision, even a conglomerate becomes less competitive in an instant due to the nature of the rapidly changing IT industry. Samsung Electronics will also have no choice but to follow in the footsteps of Nokia, Motorola, Kodak and Sony, which had been once considered the world’s number one in the industries, when the company fails to find a new future growth engine as soon as possible.”
Samsung's chip business has driven yet another mighty set of results, making it the perfect time to deal with all of governance issues that continue to plague the company. Q3 17 revenues and EBIT are expected to be KRW62.0tn / KRW14.5tn, slightly ahead of estimates at KRW61.8tn / KRW13.4tn. While these results are not very far ahead of expectations, Samsung has generated 2.8x more EBIT than Intel is expected to have generated in the same period, which will put Samsung's chip business comfortably in the global No. 1 slot where it looks it is going to stay for some time. Handsets also had a good quarter driven by its well-received flagship products but the real star of the show remains semiconductors. Typically, an environment of limited supply and strong demand is ruined by over enthusiastic capacity additions but we see the semiconductor industry being a little bit more cautious these days. It is due to the prohibitive cost of building a cutting edge fab and the fact that worries regarding Moore's Law grinding to halt are now firmly on the investment horizon. The big question mark remains China which has said that it wants to create its own semiconductor industry (not including Taiwan) and aggressive roll-outs there could cause yet another demand / supply imbalance. Either way this will take some time, meaning that Samsung's chip business is likely to continue generating vast profits for at least 12-24 months. Against this backdrop, the outlook for the shares remains pretty steady, which makes it the perfect time to deal with the corporate governance issues that have been plaguing the company. This appears to have begun in earnest with the resignation of Co-Vice Chairman Oh-hyun Kwon who has also been serving as CEO. With Jay Y Lee also likely to out of the picture for a few years, the way is open for new blood to take the helm of Samsung and clean up these long-standing issues. This is becoming increasingly important, as the long-term discount in Samsung's valuation has evaporated over the last 18 months. This means that the murky way that the company is owned, controlled and managed needs to be changed into something much more transparent. Failure to do this effectively is likely to result in a big correction in the valuation as soon as the current business momentum hits a bump in the road. According to the (FTC) of Korea on October 16, as it has been pointed out as a problem that Lee Kun-hee, chairman of the Samsung Group and Shin Kyuk-ho, chairman of the Lotte Group, have been unable to conduct their management activities as heads of the two groups for a long period of time but officially remain heads of the two groups, the FTC has decided to devise improvement measures to designate persons as heads of Korean business groups in accordance of the purpose of relevant laws and reality.
According to the Fair Trade Act, the head of a business group means a person who controls a business group (Chaebol). The Fair Trade Act stipulates that a business group has to have a 30% or more stake in its affiliate but there is no separate qualification requirement for the head of a business group in the act.
Chae Yi-bae, a lawmaker of the People’s Party also proposed an amendment to the Fair Trade Act to the National Assembly on September 29. The amendment blocks those who are neither sensible nor able to conduct economic activities independently from becoming business group heads.
"Lee Kun-hee, chairman of Samsung, has been unconscious for three and a half years since May 2014, and Lotte's general chairman Shin Kyuk-ho has failed to carry out normal business activities since several years ago,” lawmaker Chae said. “It is impractical for the FTC to designate the two people as heads who control Samsung and Lotte."
"We have not yet determined whether to restrict business group heads’ qualifications through an amendment to the Fair Trade Act or other ways," an FTC official said. "We are planning to finalize it before the selection of a group of large enterprises in April of next year after collecting the opinions of the business world."
It is forecast that when qualifications for business group heads are restricted, the head of the Samsung Group will change to vice chairman Lee Jae-yong from chairman Lee Kun-hee and the head of the Lotte Group to chairman Shin Dong-bin from general chairman Shin Kyuk-ho when the FTC announces the list of large enterprises in April of next year.