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Morningstar | Market Worries About Price Decline of Memories, Rich Dividends Will Support Samsung's Share

Samsung Electronics' operating income for the June quarter was KRW 14.9 trillion, which was below our forecast of KRW 15.4 trillion. Despite the price decline on NAND flash memories, Samsung's operating margin for the device solutions segment reached a historical high of 42.2%, slightly above the previous quarter of 41.5%, which was driven by the robust DRAM demand. Demand for servers remained strong, and content growth for smartphones also supported the growth, which we believe will continue in the second half of 2018. Meanwhile, shipment of its smartphones, including the flagship Galaxy S9, was below our expectation, becoming the main reason for the shortfall. The company expects that the launch of Galaxy Note 9 will reignite the shipment momentum in the September quarter, but we are somewhat skeptical about the sustainability. Accordingly, we made minor updates to our earnings forecasts, and no change to our fair value estimate of KRW 56,000 per share and USD 1,300 per GDR.

Samsung disclosed its plan to use KRW 180 trillion for capital expenditure and R&D cost for the next three years in growth areas, such as artificial intelligence, 5G technology, electronic components for autos, and biopharmaceutical. The investment is used for memory chips and display panels, and is KRW 10 trillion larger than its spending over the past three years. We believe the investment is reasonable, and will contribute to reinforcing Samsung's cost advantage, which is the source of our narrow moat rating.

As discussed in our previous note, while we consider that Samsung's current share price is undervalued, we acknowledge three major concerns: 1) expected price decline of NAND in the second half of 2018 and DRAM in 2019; 2) potential entry of Chinese manufacturers to the memory market in 2019; and 3) potential pressure on Samsung Life to sell approximately two thirds of its stake of Samsung, as the bill to limit share cross-holdings by insurance companies is expected to be submitted. We consider that it will take some time for these concerns to be cleared, but meanwhile, the downside on Samsung's share price will be limited as the current dividend yield of 3% may look attractive for investors, which is following Samsung's new shareholder return policy.