Shares of the electronics giant fell 6.2% in Korea after profits didn't meet expectations. Samsung's business environment is also a concern

At first blush, the quarterly results for Samsung Electronics don't look so bad. The Korean company on July 25 announced a 51% year-on-year rise in its second-quarter net earnings, a 12% profit margin on sales of $18 billion. But that fell short of expectations and was 2% lower than the previous quarter, largely due to the U.S. credit crunch and high oil prices. Still, while Samsung's $2.12 billion net income may have been some $200 million less than what many corporate analysts had forecast, the company managed a better performance than most of its rivals.

Yet a closer look at its strategy and its business environment makes investors feel uncomfortable, to say the least. After the earnings announcement, Samsung shares plunged 6.2%.

The disappointing earnings come at a difficult time for Samsung. The company has been hit by a tax-evasion scandal involving its top executives. And executives acknowledge Samsung won't achieve significant improvement soon. "The visibility is quite low," says Executive Vice-President Chu Woo Sik of the memory chip business.

Traditionally Samsung's cash cow, that division is suffering as the chip industry goes through a supply glut. The operating profit margin in the semiconductor unit slightly rose to 6% in the second quarter from 4% in the previous quarter, thanks to productivity gains made through migration to thinner circuit printing technology. But that was a far cry from the 31% margin posted some 18 months ago. The income from the chip business was $268 million, less than a quarter of earnings during the top of the chip cycle.

"Out to Strangle" Memory Chip Rivals
Nevertheless, Samsung is cranking up output. Hong Wan Hoon, Samsung's vice-president at its semiconductor unit, told a conference call with brokerage analysts that its output this year in DRAM, or dynamic random access memory chips used largely in PCs, will be double the pace of industry growth. In coming years, "we expect our market share to gain by one or two percentage points each year" from the mid-30s toward the high 30s, Hong said.

Samsung is also pouring money into new facilities. Chu says Samsung, the only profitable memory chipmaker now, is committed to investing more than $7 billion this year in new chip production facilities "to further widen the gap" with its rivals. Other makers of DRAM chips had hoped that spending cutbacks and a demand pickup ahead of the holiday season would trigger a second-half recovery, but the prospects for a significant rebound are fading with the leader continuing to expand supply.

Industry watchers call Samsung's move a risky bet. "Samsung is out to strangle the weak player," says Kim Soo Kyoum, semiconductor director at researcher IDC. "It will hit a jackpot with an expanded market share if failing chipmakers exit the industry, but if they survive the industry slump could persist much longer."

LCD Unit Shines
The outlook for Samsung's other major business isn't all that bright either. The Korean electronics giant, the undisputed leader in memory chip manufacturing, is also the biggest maker of TVs, liquid-crystal-display panels, and the No. 2 player in the handset business. Yet some LCD panel makers have begun cutting back production in the face of rising inventory, TV makers are locked in a cutthroat race to lower retail prices, and two of the top five handset makers are bleeding red ink.

The star performer was the LCD unit. Supported by brisk sales of flat-screen TVs, it posted an operating profit of $992 million for a margin of 21%, down from 23% in the first quarter but up sharply from 9% a year earlier. Industry officials point out, though, that an oversupply is imminent after a year of facility expansion during the boom year; Samsung, they say, won't be immune to a cyclical downturn.

Phone Profits Dip
Another money-spinner was the handset unit. Samsung, second only to Nokia (NOK) in the handset market, sold 45.7 million phones in the April-June period, a slight dip from 46.3 million three months earlier. The margin from its telecom unit, which contributed $784 million to the company's bottom line, also dropped, to 13% from 15% in the first quarter.

That's not disappointing in view of money-losing rivals such as Motorola (MOT) and Sony Ericsson. But investors aren't impressed. "Samsung's performance is decent but is not top-notch," says Michael Min, technology sector specialist at fund manager Tempis Capital Management in Seoul. "Investors aren't convinced Samsung will be a trendsetter as wireless Internet is about to reshape the mobile-phone industry."

Source:BusinessWeek