Samsung: Huge Profit Jump

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This is the Samsung way: Bet big on a cyclical business even when rivals are slashing and burning, then enjoy an earnings windfall during the next upturn. That's pretty much what Samsung Electronics did with its memory chip unit, and the company has proven yet again it is second to none in this high-risk, high-return game.



On Oct. 15, the South Korean giant blew away consensus forecasts and posted a 45% profit jump in the third quarter of this year from the previous three-month period. On a year-to-year basis, net profits were up 16% to $2.29 billion.



Samsung, Asia's largest and most profitable information technology company, reported strong results in such core businesses as memory chips, mobile phones, and liquid crystal display panels. "Many call it an earnings surprise," says Samsung Senior Vice-President Chu Woo Sik. "We anticipate our key business units to experience significant tailwinds in the fourth quarter." Including its TV and digital audio players, the company's overall sales reached $15.92 billion in the third quarter, up 8% from three month earlier and up 5% from a year ago.



RISE IN DEMAND.

The biggest money spinner is the so-called DRAM chips used for computer memory. Many players in the semiconductor industry have discounted it as a commodity and abandoned the DRAM business, which accounts for about half of Samsung's semiconductor sales, totaling $5.14 billion in the third quarter.



Although Samsung only gives operating profit margin of 26% for the whole of its semiconductor unit, analysts put the margin for its DRAM chips at more than 35%. "The profit will likely reach 37% to 38% in the fourth quarter when demand for computer memory will rise due to [Microsoft's new operating system] Windows Vista," says Im Hong Bin, semiconductor analyst at Mirae Asset Securities.



DRAM's short supply is expected to continue for months to come. The high margin is partly due to a production shift by memory chip makers from DRAMs to NAND flash chips that store data even when power is switched off. The shift came as DRAM's application diversified from traditional use in computers to game consoles, video recorders, cellular phones, and other mobile devices. "We simply can't meet the demand for DRAM chips," says Chu [see BusinessWeek.com, 9/25/06, "Samsung: A Rosy Future for Memory Chips"].



UPPING ITS CHIP INVESTMENT.

Now, with prices falling sharply in NAND, Samsung is gearing up for more investment in the chip. "Falling prices will create new markets for NAND and its potential applications are simply enormous," said Samsung Electronics President Hwang Chang Gyu last month.



Samsung, which is meeting almost half of the world's NAND demand, is spending an extra $1.05 billion to modernize NAND production, increasing the company's total facility investment this year to $10.71 billion, about 65% for the semiconductor unit. NAND prices have more than halved so far this year but researcher Gartner Dataquest expects this year's global NAND sales to rise 29%, to $15.4 billion, as the pace of growth in demand more than offsets lowering prices.



The same strategy applies in Samsung's LCD panel unit. In contrast to its crosstown rival LG.Philips LCD, which is scaling back its investment plan, Samsung and its joint venture partner Sony (SNE) of Japan are building a $2 billion next-generation mega-factory for rolling out LCD TV panels as big as 50 inches.



HUGE LCD JUMP.

"Samsung aims to repeat its memory chip success in its LCD business and the odds seems to be pretty good," says Merrill Lynch (MER) display analyst Daniel Kim [see BusinessWeek.com, 4/11/06, "Sony and Samsung's Big HDTV Bet"].



The LCD unit is not a star performer. It earned $167 million on sales of $3.14 billion in the third quarter for a margin of only 5%. But it still represents a 115% jump in operating profits from only $73 million in the previous quarter. And Samsung investors will be pleased to know that LG.Philips, which competes with Samsung for leadership in LCD screens, reported losses totaling hundreds of millions of dollars in the past two quarters.



"Samsung has a big advantage as they have lock-in customers -- Sony and Samsung -- who are the two biggest LCD TV makers in the world," says Kim. That's a big advantage at a time when prices are plunging, particularly in view of the fact that other LCD makers are suffering from a pile of inventories. LCD panel prices for 42-in. TVs have fallen 37% to $690 in October from $1,100 in January.



"CEMENTING ITS STATUS."

Samsung investors could take the most comfort from the fact the company's telecom unit is recovering. Samsung's slide in the global mobile phone market had been a big worry as the Korean company neglected the fast-growing low-end handset segment in emerging markets such as India. Samsung's telecom unit posted an operating profit of $544 million on sales of $4.93 billion for July through September for a margin of 11%, up from 10% in the second quarter.



"It certainly is a strong signal that Samsung is cementing its status as the world No. 3 handset maker," says Ahn Young Hoe, chief investment officer at fund manager KTB Asset Management in Seoul. Samsung shipped a record 30.7 million mobile phones in the quarter, including the slim "Ultra Edition" models, which competes against Motorola's (MOT) Razr.



The weakest performer was the digital media unit that makes TVs and MP3 music players. In its home operation it showed a loss of $105 million on sales of $1.71 billion in the third quarter but Samsung officials say that distorted the financial soundness of the unit, whose overseas operations account for about 85% of sales. Moreover, all R&D and the bulk of global marketing costs were covered by the headquarters.



Chu says on a consolidated basis, digital media is estimated to have recorded a profit margin of between 4% and 5%. "No investors are buying Samsung shares because of Samsung's digital media. With the Q4 results expected to improve, Samsung remains a star player in the IT world," Ahn says.