Is Samsung in Trouble?

Learn why the world's largest smartphone maker had disappointing earnings this quarter.

Jul 14, 2014 at 2:00PM

The world's largest smartphone manufacturer, Samsung (NASDAQOTH:SSNLF), is expecting a third straight quarter of profit decline, as it forecasts profit of $7.1 billion after revenue of $51.5 billion, which is $1.4 billion lower than the Street consensus.

Profit for this quarter is down 24.5% from the same period last year, suggesting that the company is suffering from fierce competition from Apple (NASDAQ:AAPL) and Chinese players, such as Xiaomi and Huawei. To make matters worse, there's a worrying cannibalization trend of tablet sales by phablet phones. Is the world's largest smartphone maker in trouble?


Source: Samsung

The earnings
Profits are down 24.5% from the same period last year. Moreover, for the display unit, which supplies Apple and other major smartphone manufacturers, quarterly profits are expected to fall 76%, which is a signal that the entire smartphone and tablet industry may be suffering from low volumes.

In an usual step, the Korean giant released a whole page of reference material for the next quarter. This is probably an effort to reassure investors that Samsung remains committed to long-term growth. The company explained that the decrease in earnings was mainly due to phablet sales eating into tablet sales, an increase in marketing spend, adverse currency fluctuations, and weaker sales in China due to seasonality and consumers saving for upcoming 4G devices.

The phablet threat: implications for Apple
Phablets are a real threat to Samsung. The company said that "higher shipments of 5-to-6 inch large screen smartphones replaced demands for 7-to-8 inch tablets." Moreover, according to the Korean giant, phablets may have a shorter replacement cycle than tablets and smartphones.

Apple, which is said to be preparing a larger version of the iPhone, should be particularly worried about this industry trend. In the worst scenario, Apple's new iPhone could end up cannibalizing sales of the iPad, which still make up 16.7% of the company's total revenue, just like Samsung's phablets are cannibalizing sales of its tablets.

Regarding China, Samsung's earnings could be used as a proxy to forecast the numbers of Xiaomi, Lenovo, Huawei, Coolpad, and other Chinese manufacturers. Note that Apple, which signed a major distribution deal with China Mobile in January, is also highly exposed to China's weak smartphone demand.  

Emerging markets
According to IDC, shipments of tablets from India for the April-June period stood at 0.8 million units, representing a 32.8% drop over the corresponding period in 2013.

Note that the same market research company lowered its 2017 tablet forecast in late 2013 from 407 million to 386.3 million, taking into consideration increasing phablet sales.

The phablet threat may be particularly strong in emerging markets, where customers must choose between a phablet or a tablet, due to budget constraints. This is clearly a bearish signal for the whole industry, as most smartphone and tablet manufacturers see emerging markets as key growth drivers, due to their relatively low smartphone penetration rate.

Final Foolish takeaway
Although the Korean giant is currently suffering from the phablet threat, fierce competition from Chinese manufacturers, and weak demand in key markets, it's important to note that demand for Samsung products still remains high. Additionally, it should be noted that the Korean giant suffered from some extraordinary events in the first quarter, such as adverse currency fluctuations (the Korean Won is trading at six-year highs) and seasonality. 

Going forward, the Korean giant may see a slight improvement in the next quarter, as it is preparing new product launches in the second half of the year, including the promising Galaxy Note model. However, a long-term improvement in earnings may only be achieved by applying a strong differentiation strategy. Unfortunately, this is going to be increasingly difficult, as Chinese competitors such as Xiaomi are showing strong commitment to innovation, despite their smaller R&D budgets. 

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Victoria Zhang has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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