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1) From 2019 to 2021, earnings are expected to increase by 80%
2) This can help narrow its 50% valuation gap to smartphone peers
3) Other factors (50% Free Cash Flow distribution, Kioxin IPO)
The InvestQuest’s View
We see Samsung Electronics as a potential catch-up play to the broader tech sector, as it benefits from several short-term price catalysts. As the largest smartphone maker, the company is expected to benefit from Huawei’s expected loss in smartphone market share. Earnings should also be boosted by sustained growth in the memory chip sector. Stock valuations are inexpensive on P/E and P/B metrics and should remain supported given the company’s 25% net cash position (relative to market cap). We also see the potential for a share buyback or special dividend announcement to happen shortly.
Disclaimer: We have shares in Micron and Samsung Electronics’ London-listed GDR (the GDR is denominated in USD, and each GDR share represents 25 shares of its Korea listing).
Samsung Electronics: Key Segments
- Mobile Devices: No. 1 Smartphone Maker in the World (18% market share). While Apple currently has the largest global stock market cap at US$2tn, Samsung Electronics actually sells more phones (295m phones in 2019, versus Apple’s 190m)
- Memory Chips: No. 1 Memory Chip Maker in the World (44% market share of DRAM market & 33% of NAND market in 2019). Click here to understand what DRAM and NAND are. To provide context on Samsung Electronics’ scale, the revenues generated from Samsung’s Memory Division is roughly 2.5x that of Micron’s (a US-listed competitor) total revenues.
- Others (Consumer Electronics and Display Panels). I’m sure you have seen Samsung TVs, washing machines and fridges. The company also manufactures certain components such as OLED display panels and batteries for companies such as Apple and Huawei.
1) From 2019 to 2021, earnings are expected to increase by 80%
Analysts are currently projecting an 80% increase in net profit from US$16bn in 2019 to US$29bn in 2021, mainly for the following reasons.
- Smartphones: Sales to benefit from USA’s trade restrictions placed on competitor Huawei.
- Memory Chip: Easing of market oversupply in 2021 to stabilize sales prices, while memory sector volume growth is sustained at double digit percentages.
Here’s a chart on Samsung Electronics’ revenue and net profit. Note that the numbers are in Korean Won.
SMARTPHONES: On Huawei sanctions
On most recent Huawei sanctions (effective 15 Sept): Under new rules issued by the US Commerce Department, any company that sells Huawei any products made anywhere with US technology will require a licence. This is expected to lead to severe lack of components for Huawei’s smartphones.
It is estimated that Huawei’s Smartphone shipments will fall 70% year-on-year, from 192.7m units in 2020 to 59m units in 2021 (source), as a result of the most recent set sanctions.
SMARTPHONES: Which competitors will gain?
The main question is which smartphone competitor will stand to benefit from Huawei’s fall in market share. Huawei is currently the world’s No. 2 smartphone maker by sales. As a Chinese brand and one that sells smartphones on the lower end of the price range, the likely beneficiaries of the sanctions are other Chinese players like Xiaomi (publicly listed), Oppo (private), and Vivo (private).
SMARTPHONES: How about Samsung Electronics?
However, Samsung Electronics stands to benefit too. According to news sources, Samsung Electronics expects its smartphone shipments to increase by 15% next year – from a forecasted 260m smartphones in 2020, to 300m in 2021. Analysts are also forecasting an increase of that magnitude. Assuming that the bulk of this increase will come as a result of the Huawei sanctions, it suggests that Samsung Electronics expects to capture around 30% of Huawei’s expected loss in market share.
We find this 30% capture believable given that 1) Samsung is the No. 1 player worldwide, 2) concerns over potential US sanctions against other Chinese phonemakers, and 3) recent boycotts against Chinese products in India.
What’s the effect on segment profit? Analyst projections for Smartphone Segment’s revenue change ranges from +7.5% to +28.6% (2021F vs 2019). Projections for operating profit change ranges from +21.2% to +78.0% (2021F vs 2019), translating to a US$1.6bn to US$5.2bn increase.
Our own back-of-the-envelope calculations suggest a 13% increase in segment operating profit (approximately +US$1bn) versus 2019 levels. This is IF one assumes that margins remain the same, instead of growing as they should when volumes improve (see Appendix 1 for details).
That’s for the segment. Recall that for Samsung Electronics as a whole, analysts are currently projecting a US$13bn increase in net profits from 2019 to 2021. So, the bulk of the increase is expected to come from the Memory Chip Segment, which you can read about below.
MEMORY: Oversupply expected to ease in 2021
In the short-term, there’s an oversupply of memory chips which is expected to lead to downward pricing pressure (on both DRAM and NAND) for 2H2020.
But analysts are projecting this memory chip oversupply to ease in 2021. In particular, Goldman expects to see a sequential improvement in DRAM price trends in 2021, given expectations of slight undersupply then (see chart below).
MEMORY: How about Samsung Electronics?
As the No. 1 Memory Chip maker globally, Samsung Electronics is expected to benefit from this market rebalancing.
For the rest of 2020, the management is optimistic that memory chip demand will be led by the launch of new smartphone models and game consoles. In addition, increased sales to Huawei may also be expected for 3Q2020, as Huawei has been stockpiling memory chips before sanctions were made effective on 15 September.
Looking ahead to 2021, with regards to Samsung Electronics’s Memory Segment, analysts are projecting a 13.0% to 67.5% increase in revenue and a 49.5% to 201.1% increase in operating income (comparing 2021 to 2019). In US$ terms, this translates to a US$5.3bn to US$22.2bn increase in operating income!
The optimism shared by analysts is driven more on volume growth than a drastic price recovery for memory chips. In the below table, we show the median projection for memory chip sales volume and average selling prices by research analysts.
Comparing 2019 and 2021, the median analyst forecast implies a 37% and 69% growth in DRAM and NAND sales volume respectively, and a -14% and -11% decline in DRAM and NAND average sales price respectively (see table below for details).
2) Potential for Samsung Electronics to narrow its 50% valuation gap to smartphone peers
SMARTPHONES: Samsung’s valuation gap with smartphone peers has widened
Out of the Top 5 smartphone makers, only Samsung Electronics, Xiaomi and Apple are publicly listed on stock exchanges.
Since the start of the year, Apple and Xiaomi shares have rallied +48% and +107% respectively, while Samsung Electronics has only moved +8%.
This has widened the P/E valuation gap between Samsung Electronics and its smartphone peers, from a ~30% gap at end-2019 to ~50% gap currently. The chart below shows the trailing P/E of all three stocks since Jan 2010. Xiaomi listed only in 2019.
SMARTPHONES: But earnings growth should add additional pressure for this gap to close
If we consider net profit growth expectations for 2021, the valuation gap would be even more alarming. Comparing 2021F to 2019,
- Apple: Net profit is expected to increase 18%. This implies that Apple’s currently trades at 28.1x of its FY2021 earnings.
- Samsung Electronics: Net profit is expected to increase 80%. This implies that Samsung Electronics currently trades at 10.4x of its FY2021 earnings.
When valuation gaps become too disparate AND the more poorly valued stock is showing stronger growth prospects, investors have a greater incentive to reallocate their investments. In this way, Samsung Electronics’ 2021F earnings growth may precipitate a rerating in its share price.
SMARTPHONES: This holds even if we strip out “net cash”
Apple is known for having a lot of cash on its balance sheet, and so it may be argued that it appears to trade at higher P/E multiples, if you don’t recognize the value of the “net cash” (which is cash minus debt). Do note that Apple has been steadily using its cash balance to conduct share buybacks.
If we strip out “net cash”, the “ex-cash P/E ratios” of Apple and Samsung shows an even wider valuation gap because guess what…Samsung Electronics has even more net cash than Apple!
- Apple: FY2021 P/E (ex-cash) is 27.0x.
- Samsung Electronics: FY2021 P/E (ex-cash) is 7.8x.
Net cash on Samsung Electronics’ balance sheet now makes up 25% of its market cap, versus Apple’s 4%.
MEMORY: Samsung Electronics is also cheap versus its memory chip peers
The chart below shows the trailing P/E of Samsung Electronics against SK Hynix and Micron since 2018.
MEMORY: Price-to-Book of 1x has historically signaled a trough for Memory stocks
Samsung Electronics trades at a P/B multiple of 1.35x, a slight premium to its 10-year average of 1.26x.
In the past 10 years, we note that the two closest pure play memory stock peers (SK Hynix and Micron), have historically traded at a trough of 1x P/B (see chart below), not too far from current levels. We see this as providing some valuation support, with the potential for rerating in 2021.
3) Other Positive Factors for Samsung Electronics
Potential share buyback or special dividend
Samsung Electronics currently has a dividend yield of 2.3%, higher than the historical 10-year average of 1.5%.
We are expecting an announcement of a share buyback or special dividend amounting to an additional 3% yield, which may be a short-term price catalyst.
Why do we expect this? As per the current shareholder return policy, Samsung Electronics has to return at least 50% of its three-year cumulative Free Cash Flow (FY18-20). This will most likely result in a share buyback or a special dividend payout of KRW 11 trillion (3% of current market cap), which may be announced as early as the 3Q earnings release in late-Oct or early-Nov.
We derived the KRW 11 trillion expected payout using the following computation:
- J.P. Morgan estimates that Samsung Electronics’ three-year cumulative FCF for FY18-20 will be approx KRW 80 trillion. 50% of that is KRW 40 trillion.
- Samsung Electronics’ quarterly dividend has been unchanged at KRW2.4 trillion per quarter
- Subtracting 12 quarters of dividends from KRW 40 trillion will give a result of approx KRW 11 trillion
Toshiba Memory (Kioxin) IPO may buoy sector Valuation Multiples
In what would be Japan’s largest IPO for 2020, Toshiba Memory (Kioxia) will be raising up to US$2.9 billion, valuing the NAND memory manufacturer at US$18 billion (source). The Kioxia IPO will be priced on 28 September (in the range of 2,800 – 3,500 yen per share), with plans to officially list on 6 October 2020.
In a research report published on 15 September 2020, Bernstein had projected Kioxia’s 2020 and 2021 earnings before interest and taxes (EBIT) at US$1.1 billion and US$4 billion respectively, which would translate to a fair value of 2,260 yen per share (on assumptions of 10x P/E, 9x EV/EBIT and 6.5x EV/EBITDA).
The current IPO price range of 2,800 – 3,500 yen per share implies a 24% to 55% premium to Bernstein’s estimated fair value, which either means that the Kioxia IPO is overpriced OR we may see some spillover valuation support to the other memory stocks.
The InvestQuest’s View
We see Samsung Electronics as a potential catch-up play to the broader tech sector, as it benefits from several short-term price catalysts. As the largest smartphone maker, the company is expected to benefit from Huawei’s expected loss in smartphone market share. Earnings should also be boosted by sustained growth in the memory chip sector. Stock valuations are inexpensive on P/E and P/B metrics and should remain supported given the company’s 25% net cash position (relative to market cap). We also see the potential for a share buyback or special dividend announcement to happen shortly.
Disclaimer: We have shares in Micron and Samsung Electronics’ London-listed GDR (the GDR is denominated in USD, and each GDR share represents 25 shares of its Korea listing).
Appendix 1: Samsung Electronics Smartphone Segment Profit Estimates for 2021
In Section 1 earlier, we had estimated a 13% increase in operating income for Samsung Electronics’ Smartphone Division in 2021 (translating to US$1bn), as a result of Huawei’s market share erosion. Our computations and assumptions as follows:
- Revenue per Smartphone unit (2017-2019): US$300 per phone
- Projected increase in Smartphone unit sales for 2021 (vs 2020): 40 million
- FY2019 operating income margin for Smartphone sales: 8.6%
- Incremental increase in revenue for 2021 (vs 2020): 40 million units * US$300 = US$12 billion
- Incremental increase in operating income for 2021 (vs 2020): US$12 billion * 8.6% margin = US$1 billion
Appendix 2: Impact of Huawei sanctions on Samsung Electronics’ component business?
While Samsung Electronics’ smartphone business should benefit from Huawei woes, we note that the company does supply a fair amount of components (i.e. memory chips, OLED panels and CMOS image sensors) to Huawei as well, so there should be reduced sales from the component business.
In Samsung Electronics’ 2019 Annual Report, Huawei was disclosed to be Samsung’s top five customers, the other four being Apple, Bestbuy, Deutsche Telekom and Verizon. These five companies contributed 13% of Samsung Electronics’ total sales.
In terms of revenue impact, if we assume Huawei makes up 5% of Samsung Electronics’ revenues, this would have translated to US$10 billion in 2019. This would be offset by Samsung Electronics’ expected smartphone sales growth of US$12 billion.
Over the longer term, we expect the impact to Samsung Electronics to be manageable, as the company is also a component supplier to other smartphone competitors, where we might see incremental demand.
In the short term, Samsung Electronics’ 3Q2020 result should surprise on the upside, as Huawei has been hastily stocking up component inventory ahead of sanctions made effective on 15th September 2020.
Appendix 3: Analysts Ratings and Target Prices
We include all the analyst ratings and their target prices that have been reviewed on and after 1st September 2020. Consensus is generally bullish on Samsung Electronics.
Do note that the below shows the ratings for Samsung Electronics’ Korea-listed shares. Most international investors would invest via the London-listed GDR that is denominated in USD, and which represents 25 shares of the Korea listing.
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