[INTERVIEW] Samsung expected to show resilience in earnings, but SK to report loss: S&P

Pedestrians walk past a money exchanger in downtown Seoul, South Korea, Wednesday, Jan. 11, 2023. AP-Yonhap

This article is the last in a series of interviews with chief economists and analysts covering the Korean economy and industries on what the global credit rating agencies expect for 2023 amid rising interest rates and high inflation. ― ED.

EV growth, disciplined financial policy to benefit LGES, POSCO

By Kim Yoo-chul

Samsung Electronics recently reported an earnings shock for the fourth quarter of last year, while SK hynix, which saw a 60 percent drop in operating profit in the third quarter, is expected to have suffered an operating loss of during the final quarter of 2022.

But Korea's semiconductor industry, which is one of the main pillars of the country's exports, is expected to face tough market conditions this year.

Memory semiconductors, including contract-based chips and image sensors, account for about 27 percent of the entire chip industry's estimated value of $619 billion as of 2022, according to Gartner, a market research firm. Memory chips, which are considered as commodities, are sensitive to rapid shifts in demand.

From a profit standpoint, the COVID-19 pandemic was a huge plus factor for all memory chip manufacturers, including the Korean chip duo, and Micron Technology (Micron) of the United States, as demand for tech products surged and supply constraints led chip prices to soar.

But higher inflation, continued supply chain problems, growing geopolitical risks and rising interest rates have caused massive pullbacks in sales of memory-heavy tech products such as smartphones, gaming consoles and PCs. That also means top clients have shifted toward adjusting inventories to save fixed costs, resulting in all sector leaders suffering from a high level of inventories, which could also mean that pricing trends will get worse.

Speaking to The Korea Times, a senior official at S&P Global Ratings said the Korean chip duo aren't out of the woods yet.

S&P Global Ratings Director Park Jun-hong, left, and the credit rating agency's chief Asia economist, Louis Kuijs / Korea Times file

"The industry downcycle will likely continue well into 2023, on oversupply and average selling price (ASP) pressure from weak demand for PCs, smartphones and servers. Weak demand, large inventory and tightening regulations imposed by the United States on China will continue to weigh on operating performances," Park Jun-hong, the agency's director, said in a recent interview. S&P is considered to be the largest of the big three credit-rating agencies, which also include Moody's Investors Service and Fitch Ratings.

Citing high exposure to the memory business, the S&P director expects SK hynix to remain unprofitable until the end of June this year.

"SK hynix will likely turn in a large operating loss in the fourth quarter of last year and the first half of 2023. The NAND flash business, in particular, will take a longer time to recover, adding downward pressure," Park said. But he declined to elaborate on the possibility of the rating agency adjusting its view on the SK Group's semiconductor affiliate.

DRAM chips are said to account for about 70 percent of SK's annual revenue. SK hynix is seen to have reported an operating loss of 800 billion won during the last three months of 2022, a disastrous decline from the 4.2 trillion won operating profit it achieved during the same period of the previous year.

The S&P official, however, highlighted two strengths of sector leader Samsung ― a widened business profile and abundant cash holdings ― as these merits will help the company minimize losses.

"Samsung Electronics, meanwhile, could remain relatively resilient, given its more diversified business portfolio and significant financial buffer with solid net cash position," the director answered.

Samsung's semiconductor business is seen to report around 1.5 trillion won in fourth quarter operating profit, which also a huge drop from 8.8 trillion won the previous year. Investors are eagerly hoping that Samsung will announce plans to reduce chip production, as SK and Micron have committed to more than a 50-percent reduction in expenditures this year. Such moves are viewed as a positive signal in terms of addressing the industry's oversupply concerns.

President Yoon Suk Yeol, second from left, and U.S. President Joe Biden, left, look around Samsung Electronics' semiconductor plant in Pyeongtaek, Gyeonggi Province, May 20, 2022, with Samsung Electronics then Vice Chairman Lee Jae-yong, third from left. Korea Times photo by Seo Jae-hoon

Company sources said Samsung will probably adjust investments by postponing the introduction of necessary equipment or other flexible ways.

Despite headwinds, credit impact limited for LGES, POSCO

The director went on to say that slower growth, weak demand, inflation and higher interest rates will add strain to the Korean companies' operating performances throughout this year. Plus, he added that the creditworthiness of Korean corporates has begun to show a weakening trend since the second half of 2022.

"We expect a tougher operating environment in 2023. We view sectors such as semiconductors, steel, oil & chemical as most at risk, while some sectors with structural growth momentum could fare better," Park responded.

Citing today's structural shift towards the electronification of vehicles, the S&P director said LG Energy Solution (LGES), a major battery supplier for Tesla, could be one of the top beneficiaries of the increase in the penetration of electric vehicles (EVs) in North America.

"EV battery makers are investing in capacity additions, jointly with the auto original equipment manufacturers (OEMs) to address growing demand. But potential risks could include the significant capital expenditure burden from new investments, rising input costs affecting profitability and execution risks including potential quality-related costs," he answered without providing the specifics of its view on the LG Group affiliate from a credit standpoint.

POSCO Holdings will feel pressure to maintain profitability in the challenging market this year. However, its prudent financial policy should help it keep operating.

Tesla and SpaceX Chief Executive Officer Elon Musk speaks at the SATELLITE Conference and Exhibition in Washington, March 9, 2020. Owning Tesla stocks in 2022 has been anything but a smooth ride for investors. The electric vehicle maker's stock price is down nearly 70 percent since the start of the year, on pace to finish in the five biggest decliners among S&P 500 stocks. AP-Yonhap

"The operating performance of POSCO could come under pressure in 2023, given sluggish steel demand on the back of slower industry demand and the growth outlook for the year. That said, credit impact could be limited, despite operational headwinds, as we view it will maintain a sufficient financial buffer thanks in part to its disciplined financial policy," Park elaborated.

In response to detailed questions about why investors should focus on industries which have substantial domestic market exposure this year, the director responded: "We view industries with a relatively more balanced supply-demand dynamic could be stable in 2023. Telecom and internet companies are in this category, given their predominantly domestic consumer base and the relatively stable nature of the services they provide."

Cautious fiscal policy needed to limit tightening

In a separate interview, Louis Kuijs, chief Asia economist at the rating agency, said that with the U.S. interest rates likely to rise this year and Korea's current account position remaining strained by high energy prices and subdued exports, the Korean currency, the won, will "clearly limit any room" for monetary policy easing by the country's central bank, the Bank of Korea (BOK).

"Inflation considerations do not warrant such easing any time soon anyway. To bring inflation down to the BOK's target range of 2 percent, plus and/or minus 0.5 percent, interest rates should probably be raised a bit more in coming months. Headline consumer inflation is very likely to exceed the BOK's medium-term target in 2023 ― we expect consumer price index (CPI) inflation to average 3.8 percent this year ― but it should fall below 2.5 percent in the course of 2024 if inflation expectations remain reasonably well-anchored," Kuijs responded.

The BOK is widely expected to raise its benchmark rate by 25 basis points to 3.5 percent at January's monetary policy meeting scheduled for January 13.

A trader reacts on the floor of the New York Stock Exchange at the closing bell on December 30, 2022 in New York. AFP-Yonhap

Given the relatively tight labor market and substantial wage increases, it would be best if the task of reducing inflation was not left solely to the BOK, according to the economist.

"Comparatively cautious fiscal policy would help tame demand pressures and thus limit the required monetary tightening. That would be preferable, given the financial stress that elevated interest rates can create amid high domestic debt."

Regarding his assessment of pressure on capital outflows on major Asia-Pacific currencies amid the rising U.S. interest rates, Kuijs said the exchange rate in Korea will remain particularly vulnerable because the current account has worsened to some extent in the country, Asia's fourth-largest economy, due to rising energy bills.

"Improved fundamentals and policy make financial turmoil less likely. Exchange rates have become more flexible, which helps by absorbing external pressure without depleting foreign exchange (FX) reserves. Indeed, foreign reserves are unlikely to decline to dangerously low levels any time soon in the major Asian EMs. However, the worsening of external balances noted above in some of the net energy importing Asian economies including South Korea make them vulnerable to changes in sentiment and reversals of capital flows. Policymakers in these economies may have to tighten fiscal and monetary policy to reduce external vulnerability," Kuijs said.