Uncertainties towards a Potential Overhang
The author is an analyst of NH Investment & Securities. He can be reached at dongyang.kim@nhqv.com. -- Ed.
We view the mid/long-term earnings growth potential of Samsung SDS’s IT services division as remaining intact, helped by an ongoing acceleration in digital transformation. With IT investment now recovering after having temporarily slowed following the Covid-19 outbreak, the firm’s earnings look set to normalize. But, the impacts of governance issues stemming from the initiation of an inheritance process are to be in play.
Earnings to normalize; governance issues in play
After having temporarily slowed following the Covid-19 outbreak, IT investment is now recovering. Entering 2H20, earnings at Samsung SDS’s IT services division are normalizing on both the execution of new projects and a resumption in the securing of non-captive clients. Influenced by the Covid-19 crisis, moving forward we expect to see a further acceleration in digital transformation encompassing higher demand for cloud services and a vitalization of contactless-related business at Samsung SDS’s clients. In addition, anticipated M&As based upon the company’s strong financial status (net cash of W4.1tn, 2021F EBITDA of W1.3tn) should strengthen its business competitiveness.
Due to the initiation of an inheritance process, the Samsung Group’s founding family members are expected to sell their stakes (combined holdings of 17.0%) in Samsung SDS. Uncertainties towards a potential overhang issue present a negative, but we believe that any such impact will be partly be offset by: 1) a potential strengthening in EV amid a need to meet an inheritance tax burden; 2) likely efforts to minimize the effects of stake disposals; and 3) the group (SEC 22.6%, Samsung C&T 17.1%)’s strong control over Samsung SDS.
3Q20 review: Earnings prove strong at logistics BPO division and normalize at IT services division
Samsung SDS booked consolidated 3Q20 sales of W2,968.2bn (+12% y-y) and OP of W219.8bn (+6% y-y), with both figures topping consensus.
Earnings growth was led by the logistics BPO division (sales of W1,633.5bn, +27% y-y). With major client Samsung Electronics (SEC) enjoying robust earnings, and with the cargo orders being pre-emptively secured in the run up to yearend, both trading volume and freight rates were strong—the division showed OPM of 2.1% (W34.0bn +29% y-y). Influenced by both the resolution of a delay in sales and the delayed execution of planned investment, earnings proved stable y-y at the IT services division. Recovering from tepid earnings in 1H20, the division booked 3Q20 OP of W185.8bn (+3% y-y) and OPM of 13.9% (+0.8%p y-y).
In 4Q20, Samsung SDS’s overall OP (W259.6bn) will likely drop by about 20% y-y on: 1) the impact of trading volume pre-emptively secured in 3Q20 at the logistics BPO division; and 2) y-y high-base effects at IT service division, which had a surge in earnings in 4Q19 on the booking of high value-added projects.