October 12, 2017 / 6:14 AM / a year ago

Fitch Upgrades Samsung Electronics to 'AA-'; Outlook Stable

(The following statement was released by the rating agency) SEOUL, October 12 (Fitch) Fitch Ratings has upgraded South Korea-based Samsung Electronics Co., Ltd.'s (SEC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'AA-' from 'A+'. The Outlook is Stable. The agency has also upgraded SEC's senior unsecured rating to 'AA-' from 'A+'. The rating upgrade reflects our belief that SEC's credit quality is not significantly vulnerable to foreseeable events. This is due to the growing strength of the company's major businesses, which is driven by their strong global market positions, technology leadership, diversification, economies of scale and vertically integrated structure. Although the company is exposed to potential cyclicality in the semiconductor and display panel segments and the likely decline in handset margins in the medium term, we expect operating and free cash flow generation to remain robust because of the strength and diversity of the company's businesses. KEY RATING DRIVERS Strong Leadership in Semiconductors: SEC's advanced technology in the memory sector is likely to further solidify its position as a global leader and support healthy margins. The company's large investments in technology innovation and capacity expansion have helped it to achieve sustainable improvement in market share. We believe that the strong rally in DRAM and NAND prices as a result of undersupply is likely to be reversed as production capacity increases, but the downside for SEC is likely to be to be limited because of diversifying end-market applications for the chips and increasing server demand, which is less elastic to price. We expect SEC to generate exceptionally high profit in 2017 with around 40% EBIT margin, which we forecast to decline moderately from 2018. OLED Offsets Weak LCD: SEC will be the major beneficiary of the increasing adoption of organic light-emitting diode (OLED) displays in smartphones because it dominates this technology. Gains in the OLED segment will outweigh weakness in the liquid-crystal display (LCD) panels due to oversupply and slowing TV demand. SEC practically monopolises the market for small OLED displays, and Fitch expects the supply of OLED screens to Apple Inc., which recently launched a new iPhone, to boost display revenue by double digits and expand segment margin substantially in the medium term. In contrast, the LCD market will remain subdued on continued capacity increases in China. Handset Margins under Pressure: Fitch expects handset margins to decline gradually to the high single digits over the medium term and account for around 20-25% of the company's total operating profit. (2016 EBIT margin: 10.8%, contribution to overall profit: 37%) Margins are under pressure from tougher competition and narrowing product differentiation as lower-cost competitors' handsets improve. Price competition may also limit the extent to which the rising component costs can be passed on to customers, although we expect SEC's brand to maintain a price premium in the short to medium term. We see the launch of new flagship models (such as the Galaxy Note8) as sustaining cash flows rather than improving profit because intensifying competition in the premium segment will require increased marketing spending. Stable Consumer Electronics: We expect steady profitability for its SEC's appliance and TV operations over the long term due to its strong brand recognition, dominance in the high-end product market and economies of scale. However, intensifying competition from low-cost manufacturers in China, falling demand with market saturation and volatile currency movements may pose downside risks. We forecast the consumer electronics business to have EBIT margin in the mid-single digits over the long term. Substantial Capex Increase: SEC is likely to increase capex to over KRW40 trillion in 2017 from KRW25 trillion in 2016 for investments in all major operations. However the capex intensity will remain lower than the industry average of around 20% due to its large business scale. The biggest capex increase will come from the NAND and OLED businesses, followed by DRAM, which will lead to solid growth in these segments as a capex is a leading indicator for future growth in the capital-intensive industry. We forecast DRAM capex to increase until 2019 while NAND and OLED capex will return to normal after most of the major investment in new lines takes place in 2017. Strong Cash Generation, Liquidity: Fitch believes that the company will continue to generate positive free cash flow despite substantial increase in capex in 2017-2018. A further increase in shareholder returns is not likely to hurt its financial leverage given the company's substantial cash reserve. SEC has a robust liquidity profile with the KRW66.8 trillion in cash and cash equivalents (including short-term investments) fully covering its total debt of KRW16.7 trillion as of end-June 2017. SEC continues to remain in a large net cash positon over the long term. Leadership Uncertainty: Fitch does not expect the conviction of the heir apparent to the Samsung conglomerate - Jae-Young Lee - to significantly disrupt SEC's day-to-day operations or negatively affect the company's credit profile. We believe that SEC's strategic direction has been clearly established and that individual businesses have been operating with enough autonomy so that Mr Lee's absence is not a key rating issue. DERIVATION SUMMARY SEC's credit profile is well-positioned among the other global peers in the technology sector. It is one of the leading manufacturers of memory chips, display panel, handsets and consumer electronics. The company's exposure to the cyclical industries such as memory chips, handsets and display panels is a weakness compared with the higher-rated Microsoft Corporation (AA+/Stable), which has higher visibility of margin underpinned by a high recurring-revenue base. SEC's margins are generally lower than that of 'A' rated peers, such as Texas Instruments Incorporated (A+/Stable) and Intel Corporation (A+/Stable), due to its exposure to the competitive consumer electronics businesses, including smartphones and home appliances. However, this is more than offset by SEC's scale, diversity, and operating cash and free cash flow generation. SEC also has one of the strongest balance sheets among peers rated in the 'AA' category, with net cash position and low leverage. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Strong revenue growth of 15%-20% in 2017, driven by the robust semiconductor and display panel businesses and then single-digit growth from 2018. - Operating margin to improve significantly to around 20% in 2017, mainly due to the strong semiconductor and display businesses. - Substantial increase in capex to KRW35 trillion-40 trillion in 2017- 2018 from KRW25 trillion in 2016 - Annual dividend and share repurchases of KRW10 trillion in 2017-2018. - SEC's cash-generating ability remains robust with FCF margin in the mid-single digits. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Fitch does not foresee a positive rating action over the medium term due to SEC's exposure to cyclical businesses and capital-intensive sectors. Developments That May, Individually or Collectively, Lead to Negative Rating Action - A decline in the company's competitiveness, a significant loss in its market share in major business segments, or lower profitability resulting in negative FCF or funds flow from operation adjusted leverage above 0.5x (2016: 0.3x) on a sustained basis. LIQUIDITY Robust Liquidity Profile: SEC retains a robust liquidity profile, with cash and cash equivalents (including short-term investments) of KRW66.8 trillion that well exceeded total debt of KRW16.7 trillion as of end-June 2017. SEC's debt is mostly a short-term trade product and the company has little financial debt on its balance sheet. SEC maintains a similar level of cash throughout the year and there is little seasonality. We expect the company to continue to maintain its net cash position over the long term. Contact: Primary Analyst Shelley Jang Director +82 2 3278 8370 Fitch Ratings Australia Pty., Korea Branch 9F Kyobo Securities Building 97, Uisadang-daero, Yeoungdeungpo-Gu Seoul, Korea Secondary Analyst Kelvin Ho Director +852 2263 9940 Committee Chairperson Steve Durose Managing Director Head of TMT, Asia-Pacific +61 2 8256 0307 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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