Samsung Stock: Attractive Risk/Reward (SSNLF)

Thesis

On January 6th, 2023, Samsung Electronics Co. (OTCPK:SSNLF) released its guidance for Q4 2022 results, and commented that the company’s operating profit is likely to drop to the lowest level in eight years. However, Samsung stock didn’t fall sharply on the news, but actually gained approximately 1.5% (005930.KS reference). Such a price action makes me confident to believe that Samsung stock might have bottomed in late September already.

On the backdrop of an ongoing global demand slowdown for consumer electronics and semiconductors, I lower my EPS expectations for Samsung through 2025. As compared to $117.16/ share prior, I now calculate a base case target price of $85.17/share. As I still see more than 50% upside for Samsung stock, I reiterate a “Strong Buy” recommendation.

Samsung’s Q4 Preliminary Results

Samsung’s preliminary results suggest that the company’s operating profit fell nearly 70% in the December quarter 2022, down to the lowest level in eight years. While analysts had expected operating profits of approximately Won 5.9 trillion, according to data by Refinitiv, Samsung said that the group’s actual operating profit is likely to be close to Won 4.3 trillion, down from Won 13.87 trillion for the same period one year earlier. According to the company statement, group sales for the period have likely decreased by 9% year over year, down to Won 70 trillion.

The sharp drop in profits is largely attributed to a slowing global economy, which has led to a depressed demand environment for consumer electronics products and semiconductors in general. In addition, the ongoing trend of customers clearing their inventories certainly doesn’t help to support the sales number.

Although the depressed demand environment is likely to persist throughout Q1 and Q2 2023, and could perhaps deteriorate further, the headwind is likely to be temporary. In fact, some firms have argued that the market could start to recover as early as H2 2023 (here, here, here) – which I personally consider to be a reasonable assumption.

The Risk/ Reward Looks Very Attractive

Reflecting on a somewhat odd price action – Samsung stock gained 1.5% after a what can be considered disastrous earnings report – I tend agree with the market that Samsung stock must be bought, not sold. Investors should consider that Samsung stock is down more than 30% from all-time highs and now trading at an incredibly attractive x3.4 times earnings before interest, taxes, depreciation, and amortization (EV/EBITDA). For reference, this is a 72% discount to the respective valuation of the industry median.

There is little reason to believe that Samsung’s enormous discount is justified. In fact, Samsung remains a strong player in the chipmaking and consumer electronics industries, known for its innovation and cost competitiveness. And there is extensive evidence that Samsung’s profit compression is not specific to Samsung: Notably, all major semiconductor companies have warned their investors about the industry-wide slowdown, including Micron (MU), Nvidia (NVDA), Intel (INTC), and Advanced Micro Devices (AMD).

That said, Samsung’s current challenges are likely just a reflection of temporary demand fluctuations, rather than a sign of long-term structural problems for the company. Reflecting on secular innovation verticals related to artificial intelligence, 5G, Internet of Things, and VR/AR, I remain confident to believe that the global demand for semiconductors will surpass $1 trillion by 2030 (as estimated by McKinsey), which would imply a CAGR of about 10%. And it stands to reason that Samsung’s business will be a major beneficiary from this secular growth tailwind.

Finally, investors should not forget Samsung’s exceptionally strong balance sheet: By the end of Q3 2022, Samsung reported approximately 89.4 billion of cash and cash equivalents, against total financial liabilities of only $8.64 billion, which results in a more than $80 billion net cash position (for reference, Samsung’s current market capitalization is a about $307 billion.

Valuation Update: $85.17 Target Price

Following Samsung’s preliminary Q4 results, I update my EPS expectations for the company through 2025: I now estimate that Samsung’s EPS in 2023 will fall somewhere between $4.6 and $5.0, as compared to $5.34 earlier. Moreover, I also lower my EPS expectations for 2024 and 2025, to $5.44 and 5.85, respectively.

Although I continue to anchor on a 3.25% terminal growth rate (one percentage point higher than estimated nominal global GDP growth), I slightly raise my required return variable to 8.5%, as compared to 8% prior. This update should reflect the global push for higher equity return premia.

Given the EPS updates as highlighted below, I now calculate a fair implied share price for Samsung stock (SSNLF reference) of $85.17, as compared to $117.16/ share prior.

Below is also the updated sensitivity table.

Risks

As I see it, there has been no major risk-updated since I have last covered Samsung stock. Thus, I would like to highlight what I have written before:

First, slowing global consumer confidence could provoke an extended depression of Samsung’s revenues, given a slowdown in the consumption of consumer electronics products and chip sales.

Second, as a technology company, a loss of competitive advantage in various business segments such as smartphones could materially influence Samsung’s long-term industry position.

Third, higher than expected R&D investments in order to realize new product initiatives and/or to defend competitive positioning could pressure operating profitability.

And finally, investors should consider that currently much of Samsung’s share price action is driven by investor sentiment. Accordingly, investors may need to stomach price volatility even though SSNLF’s fundamental business outlook remains unchanged.

Conclusion

Although I lower my target price for Samsung stock to $85.17, as a consequence of EPS downgrades through 2025 and globally higher equity return premia, my valuation estimate for SSNLF still sees more than 50% upside.

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