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How Will Apple and Samsung Weather the Coming Smartphone Market Fallout?

By Andrew Tonner - May 25, 2016 at 7:42PM

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This quarter could prove brutal for smartphone makers like Apple and Samsung, but brighter days are likely ahead in the second half of 2016.

Source: Samsung.

If you thought slowing smartphone sales had hurt tech earnings so far this year, to quote the '70s rock outfit Bachman-Turner Overdrive , "you ain't seen nothing yet." 

The gradual maturing of the global smartphone market, evidenced by its first-ever period of effectively flat growth in the first quarter,  has arguably been the most important tech industry story so far in 2016.

And if recent signals are to be believed, smartphone powers like Apple (AAPL -2.72%), Samsung (NASDAQOTH: SSNLF), Xiaomi, and others could be experiencing a rough second quarter.

From bad to worse?

One way the analyst community attempts to gauge the forthcoming financial performance of handset makers is by analyzing the companies that supply their components and build their devices.

As the thinking goes, the earnings results and guidance from the smartphone supply chain can serve as a leading indicator about the level of demand names like Apple and Samsung see for their devices. Unfortunately, if recent reports are to be believed, investors should be very concerned indeed.

During their Q1 earnings reports, an alarmingly large number of smartphone supply chain companies signaled their businesses are experiencing smartphone-related weakness in some way shape or form. Among them:

  • Japan Display switched its 2016 profit forecast to a loss and scrapped its previously announced plans to initiate a dividend.
  • Sharp's CEO stated orders from large smartphone OEMs decelerated noticeably in Q4 2015.
  • Smartphone assembler Pegatron saw its Q1 profits fall 35%, well short of analysts' expectations. Its April sales also sharply contracted, falling 16% year-over-year.
  • Apple assembly partner Foxconn's Q1 profits dropped by 9.2% compared to the prior year.
  • iPhone images sensor supplier Sony stated demand for its smartphone components has proven weaker than expected, though it will likely increase in the second half of the year.
  • Nidec, which supplies the haptic components that enable Apple's Force Touch, also saw Q1 profits decline by 18% on -- surprise! -- weaker than expected demand.

Since component suppliers need to produce their wares ahead of the production cycle of their handset customers, slowing demand from a component supplier in one quarter can precede a similar slowdown for the larger consumer-electronics name in the next quarter.

Though certainly not fault-proof, such a sweeping breakdown in market-wide fundamentals strongly suggests major smartphone makers like Samsung, Apple, and Xiaomi are experiencing slowing demand for their goods in the near term. As such, it seems fair to expect that the current quarter could be experiencing continued weakness in the sales of many major smartphone brands, though there can certainly be exceptions to any trend -- like Samsung's strong Q1, for example. The more important question for investors is, how long will this trend last?

Better days ahead?

While the smartphone market's best days of growth almost assuredly lie behind  it, the second half of this year will also likely prove better than the first for Apple and Samsung, though to varying degrees.

Source: Apple

Apple's bull thesis is undoubtedly more clear-cut here. As we all know, the iPhone 7's form factor upgrade should help drive a holiday-season upgrade cycle. This is assuming the iPhone 7 maintains Apple's long-standing design leadership. (Likely, but not a given.) Past iPhone form factor updates enjoyed an appreciable tailwind thanks to market-wide growth, each of the past three iPhone upgrade cycles has been accompanied by sales and stock price increases for the Mac maker.

Unlike Apple, Samsung has already refreshed its flagship handsets this year, and thankfully, the devices appear to be winners in their own rights. Lauded by reviewers and selling well so far this year, the Samsung Galaxy S7 and S7 Edge are some of Samsung's best high-end smartphones in recent memory.  As such, it also follows that Samsung stands to benefit among Android handset OEMs going into the all-important holiday season for consumer electronics purchases.

The halcyon days of unfettered smartphone market growth will likely never return.  However, the companies that stand the best chance of competing for market share within a mature market are likely those offering the best devices. So while the news around the smartphone market has been quite grizzly so far this year, the second half of the year will likely prove better, a fact investors would do well to note.

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