Plant maker seeks expansion at cost of profitability
By Cho Mu-hyun
Samsung Engineering, the engineering arm of the Samsung Group, is becoming a constant headache for the group's decision makers because of its deteriorating bottom line due to a reckless program of expansion.
Under CEO Park Ki-seok's leadership, the company has been aggressively winning orders abroad in various developing nations as part of the group's plan to make it the next cash-generator besides its larger affiliate, Samsung Electronics.
The result of Park's expansion plan is well reflected on Samsung Engineering's revenue growth, which grew for the seventh straight year as of 2012. Last year it posted sales of 11.4 trillion won compared to 9.3 and 5.3 trillion won in 2011 and 2010, respectively.
"The company's primary goal has been winning orders for procurement services (PS), which it and other Korean contractors excel at," said a contractor, working for a large domestic engineering firm, who does not want to be named. "It has indeed succeeded in a tremendous growth in turnovers, but the costs are now accumulating and burdening its profits."
However, its operating profit margin has been declining for four consecutive years. It was 6.4 percent last year, down from 7.5 and 8 percent in 2011 and 2010, respectively.
"It is because the biggest worry for contractors going overseas right now is to keep cost rates low," said the contractor. "Controlling quotation and costs are difficult because most of them go abroad without a substantial understanding of the local market situation. When a project is done, there is a whole list of unexpected costs added to the receipt."
"Samsung Engineering is a primary example of unbalanced growth. Because you need the margins to pay your employees and management costs, there is continual internal pressure," he added.
According to HMC Securities analyst Lee Kwang-soo, the company is expected to see a 15.7 percent decline in operating profits in the first quarter from the previous year.
"Because of the continued revenue making from overseas projects with low profit rates, we forecast poor results for the first quarter of 2013. We estimate the profit rate to be further exasperated compared to the market consensus and the previous year," he said.
He cited the reason for this to be a high possibility of surge in costs before ongoing, low profit construction projects in the United Arab Emirates and Saudi Arabia are concluded. Lee lowered the target stock price to be set at 185,000 won from 201,000 won.
A recovery will likely depend on the profit rate of other projects happening in different countries, which can only be determined after the third quarter, he said.
Despite the market situation, the company announced that it is targeting total revenue of 13 trillion won this year, which means it will continue with its current business model of winning orders abroad. "Sadly, it's because there is no alternative: there is nothing to be built, engineering wise in the local market as lucrative or in big in volume as abroad," said another contractor.
Another official, whose company serves Samsung Engineering's procurement orders, said the plant maker was also facing a need to change its turnkey project oriented business model.
Turnkey and engineering, procurement and construction (EPC) contracts, is when a contractor engineers and procures material and supplies them for its client with a design for a certain facility. Either the client or the contractor finds a sub-contractor for the labor process. As it requires more technical knowledge of construction than mere blue collar labor, has made it a highly profitable channel, until now.
"EPC and turnkey methods have been highly lucrative for domestic firms," said the official. Theses contract forms evolved from the provision of manual labor services by Korean firms in the 70s and 80s, as their know-how in building continued to advance.
"But now we have contractors from developing nations that are quickly growing to have very competitive technology and knowledge in engineering and building. Of course, they are yet to match Korean firms in terms of sophistication," he said. "However, their edge is price competitiveness and large-scale government support."
He said Samsung Engineering was internally debating about whether to offer different kind of contracts that are more profitable for the long-term as they lose out more and more to emerging competitors.
By Cho Mu-hyun
 |
| Park Ki-seok Samsung Engineering CEO |
Under CEO Park Ki-seok's leadership, the company has been aggressively winning orders abroad in various developing nations as part of the group's plan to make it the next cash-generator besides its larger affiliate, Samsung Electronics.
The result of Park's expansion plan is well reflected on Samsung Engineering's revenue growth, which grew for the seventh straight year as of 2012. Last year it posted sales of 11.4 trillion won compared to 9.3 and 5.3 trillion won in 2011 and 2010, respectively.
"The company's primary goal has been winning orders for procurement services (PS), which it and other Korean contractors excel at," said a contractor, working for a large domestic engineering firm, who does not want to be named. "It has indeed succeeded in a tremendous growth in turnovers, but the costs are now accumulating and burdening its profits."
However, its operating profit margin has been declining for four consecutive years. It was 6.4 percent last year, down from 7.5 and 8 percent in 2011 and 2010, respectively.
"It is because the biggest worry for contractors going overseas right now is to keep cost rates low," said the contractor. "Controlling quotation and costs are difficult because most of them go abroad without a substantial understanding of the local market situation. When a project is done, there is a whole list of unexpected costs added to the receipt."
"Samsung Engineering is a primary example of unbalanced growth. Because you need the margins to pay your employees and management costs, there is continual internal pressure," he added.
According to HMC Securities analyst Lee Kwang-soo, the company is expected to see a 15.7 percent decline in operating profits in the first quarter from the previous year.
"Because of the continued revenue making from overseas projects with low profit rates, we forecast poor results for the first quarter of 2013. We estimate the profit rate to be further exasperated compared to the market consensus and the previous year," he said.
He cited the reason for this to be a high possibility of surge in costs before ongoing, low profit construction projects in the United Arab Emirates and Saudi Arabia are concluded. Lee lowered the target stock price to be set at 185,000 won from 201,000 won.
A recovery will likely depend on the profit rate of other projects happening in different countries, which can only be determined after the third quarter, he said.
Despite the market situation, the company announced that it is targeting total revenue of 13 trillion won this year, which means it will continue with its current business model of winning orders abroad. "Sadly, it's because there is no alternative: there is nothing to be built, engineering wise in the local market as lucrative or in big in volume as abroad," said another contractor.
Another official, whose company serves Samsung Engineering's procurement orders, said the plant maker was also facing a need to change its turnkey project oriented business model.
Turnkey and engineering, procurement and construction (EPC) contracts, is when a contractor engineers and procures material and supplies them for its client with a design for a certain facility. Either the client or the contractor finds a sub-contractor for the labor process. As it requires more technical knowledge of construction than mere blue collar labor, has made it a highly profitable channel, until now.
"EPC and turnkey methods have been highly lucrative for domestic firms," said the official. Theses contract forms evolved from the provision of manual labor services by Korean firms in the 70s and 80s, as their know-how in building continued to advance.
"But now we have contractors from developing nations that are quickly growing to have very competitive technology and knowledge in engineering and building. Of course, they are yet to match Korean firms in terms of sophistication," he said. "However, their edge is price competitiveness and large-scale government support."
He said Samsung Engineering was internally debating about whether to offer different kind of contracts that are more profitable for the long-term as they lose out more and more to emerging competitors.
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