Must-know: Why is Samsung’s financial situation getting worse?

Samsung warned of an operating profit decline again

It all started in April this year. Samsung (SSNLF) warned that its operating profits would fall more than 4% in Q1 2014. And a few days ago, the company warned investors yet again that its operating profits would decline by a huge 24% in Q2. So what’s the issue affecting Samsung’s performance? After all, it’s the world’s largest smartphone player.

The main issue is the slowdown in demand Samsung’s facing for its smartphones and tablets. Plus, the Korean won appreciated more than 4% against the U.S. dollar during the second quarter. According to OANDA and as the chart below shows, the Korean won has appreciated about 10% during the last year. The gradual appreciation in the currency has caused the Korean won to hit a six-year high against the U.S. dollar.

Samsung faces competitive pressure across the world

Samsung released its flagship product, the Galaxy S5 smartphone, in April this year. But Galaxy S5 sales couldn’t beat Apple’s (AAPL) iPhone 5S sales in developed markets like the U.S. and Britain, according to a report from Kantar Worldpanel ComTech. This was despite the fact that iPhone 5S was released back in September last year.

In emerging markets like China, Samsung has a different set of problems to solve. First, it has to contend with local Chinese players like Huawei, Xiaomi, and Coolpad, These are becoming popular options for Chinese consumers. Second, it had to contend with increasing channel inventory of its 3G-based smartphones because China is transitioning to the faster and more efficient 4G technology. This caused Samsung to incur higher operating expenses in the form of promotional offers to unload older smartphones.

Samsung faces a different set of issues in the tablet market

In a warning note to the public about declining operating profits, Samsung said that the success of its bigger screen size smartphones is eating away at the sales of its tablets. This is because if there’s not much difference between the screen sizes of bigger smartphones and smaller tablets, consumers don’t have any incentive to buy and carry both devices.

But larger-screen tablets could still succeed in the market, as the smartphones and tablets would look different and meet different consumer needs.

Overall, the tablet market is slowing. This is because tablets have a longer replacement cycle, as consumers are under no pressure to get new devices.

The tablet market works differently that the smartphone market. Smartphones have to be replaced after the contract with telecom providers expires—especially in developed markets.

The second half of 2014 also looks tough for Samsung

Samsung is optimistic that its fortunes will turn around in the second half of 2014. It expects that its Galaxy Note 4 smartphone will be a success when it launches in September.

However, Apple is also expected to launch the iPhone 6 in September. This will likely be a success because it could launch a bigger-screen smartphone this time.

Then we have Google (GOOGL), which is becoming aggressive to tap the growth potential in emerging markets. Google recently introduced the Android One operating system specifically for cheaper smartphone vendors. It targeted at the next billion people who don’t have smartphones.

If Samsung continues its decline, it would impact ETFs like the iShares MSCI All Country Asia Information Technology Index Fund (AAIT), iShares MSCI ACWI ex US Information Technology Sector Index Fund (AXIT), and SPDR S&P International Technology Sector ETF (IPK). These funds have high exposure to Samsung.