Samsung Recall: potential risk and long-term brand damage

The immediate impact of the Note 7 incident is unlikely to be significant enough to affect Samsung Electronics’ (SEC) credit rating.

samsung reputation riskPotential long-term brand damage from the recall and production suspension of Samsung’s Galaxy Note 7 phone is a greater threat to its credit profile than the direct financial impact, which will be buffered by ample liquidity and a strong balance sheet, says Fitch Ratings.

The immediate impact of the Note 7 incident is unlikely to be significant enough, in itself, to affect Samsung Electronics’ (SEC) A+/Stable credit rating, which is supported by strong financial metrics that are in line with a higher rating.

Fitch believes that the benefits of SEC’s diversified product portfolio have reduced its vulnerability to this shock. Its other divisions, such as semiconductors, displays and consumer electronics, continue to record robust operating performance.

However, the problems with the Note 7 have raised long-term uncertainty about SEC’s handset operations, as the issues with the flagship model have highlighted weaknesses both in R&D capabilities and the company’s capacity to efficiently remedy serious hardware defects. Note 7 and other potential SEC handset customers may now chose Apple – SEC’s principal competitor in premium handsets – or mid-tier companies, if damage to the Samsung and Galaxy brands is sustained.

Industry experience, such as the decline of Nokia and BlackBerry, shows how successful manufacturers can lose market share particularly quickly in the handset business. This is due to the fast pace of technological change and the frequency with which many consumers change their handsets.

SEC revised down its preliminary 3Q16 results on 12 October 2016 from the previously announced figures. Operating profit decreased by one-third to KRW5.2trn (USD4.7bn), which is now 30% lower than the same quarter last year.

The revision is to reflect the cost of the decision to scrap the Note 7, which is estimated to reach around KRW2.6trn (USD2.3bn). We expect SEC’s profit for the next few quarters to be affected by a loss of smartphone sales and additional expenses related to the Note 7, such as legal claims. Nevertheless, SEC’s balance sheet will remain healthy, underpinned by strong liquidity and relatively low debt.

SEC had KRW73.2trn of cash and equivalents as of end-June 2016, sufficient to cover KRW12.3trn of total debt – which is mostly a trade-finance facility.

Samsung recalled 2.5 million Note 7 smartphones in September 2016 after a number of the units spontaneously burst into flame. Faulty batteries were blamed at first, and Samsung issued replacement phones that it claimed were safe.

However, the new phones suffered the same problem, and Samsung asked consumers to switch off Note 7s on 11 October. All production and sales of Note 7 handsets have been stopped, and the model has been withdrawn.