Samsung Q3 21 – Supercycle.

Samsung sets the tone for the supercycle. 

• Samsung’s strong results herald a super cycle in semiconductors that will look fantastic on the way up but is likely to be just as painful on the way down.
• Q3 2021 revenues / operating income were KRT63tn / KRT12.5tn nicely ahead of consensus of KRT59.9tn / KRT10.6tn.
• However, as is usual with this company, the notion that the results would be very good had already seeped out into the market meaning that the shares barely reacted to the good news.
• The results also contain a one-off gain related to the display business which is thought to be a payment from Apple as the volumes of iPhone Mini displays have not met the guaranteed level.
• Shortages of semiconductors have hurt the ability of Samsung’s device businesses to produce consumer electronics meaning that it is the semiconductor business that has been the real engine of these results.
• Currently, the market is perfectly positioned for Samsung where it can sell everything chip it makes and does so at elevated prices.
• Pricing for its two key products DRAM and NAND have been very firm during Q2 2021 and its transition to DDR5 DRAM in H2 2021 will further help pricing.
• Furthermore, I suspect that its foundry business which is the only fab other than TSMC that is capable of manufacturing at 5nm (Intel 7nm) has also seen very robust demand and pricing.
• There is no doubt that Samsung is in pole position to benefit from the semiconductor shortage, but the big question is how much of this is priced into the shares and when will the cycle turn down?
  • First, the semiconductor cycle: The causes of the semiconductor cycle are different every single time, but the result is always the same.
  • The cycle occurs because the pattern of demand for semiconductors is smooth while the supply that meets demand is very lumpy.
  • Hence demand and supply are out of balance most of the time which is what causes the cyclicality.
  • Fabs are huge constructions that take time to build and cost billions of dollars.
  • Furthermore, because they have to operate at scale, when they come into operation, supply increases in large and sudden increments.
  • This time around demand has been impacted by the pandemic and the USA / China trade dispute which has caused inventory building to coincide with strong demand.
  • The result is a big jump in demand for semiconductors while companies are scrambling to add capacity.
  • Hence, pricing will remain very robust for a while meaning that margins will expand supporting the upward leg of the supercycle.
  • As a result of the strong demand and the geopolitical tensions construction of new fabs is currently running at fever pitch and these are set to start coming online in 2022.
  • Hence, I suspect that sometime in 2022, the inventory building will cease with capacity starting to come online pretty much at the same time.
  • This will trigger a down cycle which will be particularly severe given how sharp and strong the upcycle has been this time around.
  • I would not want to hold semis when this rolls around.
  • Second, Samsung’s valuation: which remains unchallenging.
  • The shares are down from their KRW90,000 peak and with growing earnings, the multiples are not excessive.
  • Samsung is trading at 14.2x 2021 and 11.3x 2022 PER while its three-year average earnings growth is predicted to be 24% per year.
  • Google, Facebook, and Microsoft have much higher multiples and yet their growth is predicted to be less than that of Samsung.
  • This is because Samsung’s earnings are thought to be much riskier due to its geographical position and its cyclicality.
• The net result is that there is a larger than usual down cycle coming in the future but for at least the balance of 2021, the outlook for semiconductors remains very good.
• However, when I look at Samsung, the valuation is unchallenging but it is also uncompelling leaving me pretty neutral on the shares.
• I have owned Samsung in the past, but I have no inclination to jump in again at the moment.