Korean electronics manufacturer Samsung SDI Co. (006400.KS) produces products that range from lithium–ion (LI-ion) batteries for laptops and cell phones to solar panels and television components. That diversity of products is a double-edged sword, however. While it means that the company’s earnings aren’t tied to any particular segment, a shortfall in demand for one or two of its major products has the potential to affect its earnings. The low margins and declining sales volumes in the television market, combined with the plunge in prices for solar panels and the bankruptcy of some players in that market (most notably that of Solyndra) appear to be doing just that for Samsung SDI Co, which scores a weak 4 on StarMine Earnings Quality (EQ) model. In this article, we delve more deeply into Samsung’s financial statements to probe the causes of this apparent weakness in earnings quality and to look for signs of stress that could take a toll on the company’s future earnings.
StarMine has used computer-driven models to analyze the financial statements of Samsung SDI Co and more than 33,000 other companies and to calculate a proprietary StarMine Earnings Quality (EQ) score for each security. These scores have proven to be reliable predictors of the extent to which a company generates earnings that are sustainable over the coming 12 months. Expressed on a scale of 1 to 100, with a higher score indicating higher-quality earnings, the StarMine EQ score gives investors the ability to compare a company’s earnings quality against that of its peers, other companies in the same region or across the entire universe of stocks. Companies with low StarMine EQ scores are likely to have difficulty in sustaining past earnings; on the flip side, those with high StarMine EQ scores have a higher probability of being able to deliver earnings at or above current levels. With this examination of Samsung SDI Co, we continue our series of delving into the earnings quality of companies across Asia whose EQ rank signals earnings quality that is either notably high or particularly low.
In Samsung’s case, one contributor to its poor earnings quality is the gradual increase in inventory levels. The chart below shows that the inventory days stood at 47.5 days, the highest level in 18 months, at the end of the last reported quarter, ended September 30, 2011, For an electronics company, building inventory levels may signal that the business is accumulating too many products that might not find buyers, and that risk becoming obsolete as they age while sitting in warehouses. The company is also experiencing a higher level of days sales outstanding (DSO), or the number of days it takes the company to collect payment from customers. In the latest reported quarter, DSO stood at 65.5 days, setting another 18-month high. An increase in DSO and inventory days naturally leads to an increase in the cash cycle, which is currently at 76 days, exactly double the median cash cycle for the industry. The bottom line: Samsung SDI is taking twice as long to generate cash from its investments in working capital as its peers.
Source: Thomson ONE / StarMine
In the chart below, the red bars represent quarters in which Samsung SDI saw free cash flow (FCF) decline to a point where it was less than the the company’s net income. In fact, in each of the last four quarters, the company has reported negative and decreasing FCF levels. In the latest reported quarter, the FCF stood at -166 billion South Korean Won (KHW), the lowest mark for the company in more than two years. Earnings that are backed by weak cash flows tend to be unsustainable in the long run. Furthermore, the income statement reveals that a large part of the company’s net income comes from outside its core operations. In the chart below on the right, the yellow section of the bar represents non-operating income, and the blue section represents operating income. In the last quarter, operating income was KRW43 billion, but other, non-operating income was KRW93 billion, more than double the operating income. The greater the proportion of earnings that comes from operations, the more likely those earnings are to be sustainable.
Source: Thomson ONE / StarMine
It’s not all gloom and doom for Samsung SDI. The company is a major supplier of batteries for smartphones made by Apple and Samsung, both of which have been selling very well indeed over the course of the last year. However, as the StarMine EQ model indicates, Samsung SDI’s earnings quality is far from ideal, as the company is taking a hit on several other product lines.
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