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November 13, 2013

Idea of the Week: In the Driver’s Seat with Samsung and Apple

by Steven Carroll.

When fast moving consumer goods hit the highway, some vehicles eventually get left in the ditch. Among the casualties on Electronics Road are such names as Nokia, Blackberry, Palm, LG and Ericsson. Right now, the race cars in the lead are Apple and Samsung – but for how long?

As someone whose first phone was an OKI 900 in 1992, I’ve been a consumer through almost the entire drama, though I’m not old enough to have owned one of the bricks we now all laugh at in the “money never sleeps” scene in the first “Wall Street” movie.

In Q2, Samsung shipped 113.4 million phones (Source IDC), taking 26.2% of market share. Nokia was in 2nd place with 61.1 million units (at the cheap end of the market) and Apple sold 31.2 million iPhones representing 7.2% of the market.

So how does Samsung stack up as an investment case? Are investors as excited as they were over HTC, the Taiwanese handset maker that was the market darling of 2010? Exhibit 1 shows the cyclical nature of glory in the mobile phone industry. Blackberry and HTC are now a shadow of their former might and it remains to be seen whether Samsung and Apple can retain the crown for long in a field heavy with pretenders. Of course one writes off Apple at one’s peril, with the company already having returned from near oblivion once before.

Exhibit 1
Source: Thomson Reuters Eikon / StarMine

Samsung – a tough competitor

Turning to Samsung, it’s clear that the company has little intention of seeing a new competitor arrive with a smarter, faster, sleeker handset. Exhibit 2 shows the increasing cost of this arms race, with R&D as a percentage of revenue having almost doubled to 5.7% in 2012 from 3.1% in 2003. In monetary terms, the R&D spend has increased almost sixfold over that period.

Exhibit 2
Source: Thomson Reuters Eikon / StarMine

A strong base for earnings

From an Earnings Quality standpoint, Samsung also looks attractive – strong free cash flow (even after the surge in capex) and both operating profit margin and asset turnover well above the industry median.

Exhibit 3
Source: Thomson Reuters Eikon / StarMine

Samsung’s marketing strategy

With so many recent examples, it’s difficult to assume any firm can find a sustainable advantage that will persist in the consumer market, but Samsung seems to have avoided the kind of mission creep that undid their predecessors. There’s no talk of targeting the business market – the company understands it has a market leading position for the consumer and that’s the best way to ensure its ongoing success. It hasn’t attempted to enter the music arena, or indeed any content aspect – it simply tries to produce great smartphones. So far, it’s succeeding and with the market currently implying negative growth over the next five years, you’re not buying some consensus growth story. Indeed the market is saying Samsung’s growth won’t even keep abreast of inflation.

It would be dangerous to assume that new competitors won’t appear, or that Apple’s magic irrevocably passed with the death of its founder, but it seems equally unlikely that Samsung will simply stop executing – and that consumers will move onto the new, new thing immediately. With the sell side forecasting 15.5% growth for 2013 and 7.6% for 2014 – maybe it’s worth betting on these racers for a little while longer.

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