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Samsung - Limited Room for Upgrade Despite Performance

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Fitch ratings has explained why it rates Samsung Electronics debt ratings at a lower level than many other commentators would expect for the company. Fitch said that Samsung Electronics ratings are constrained in its current 'A' category due to the cyclical and capital intensive nature of its business operations, which result in low operating and FCF margins compared with other 'A' and 'AA' category technology companies rated by Fitch. This is despite record operating results in 2012, and indications of strong investor confidence.

CDS prices are implying a 'AA-' rating, one notch above Fitch's 'A+' rating - and notably two notches higher than the implied Korea sovereign CDS of 'A'. In other words, credit investors are rating Samsung higher than the state.

Investor confidence is likewise strong on the equity side, in light of the recent strength in the share price to record highs.

Fitch believes that Samsung's exposure to macroeconomic cycles - and its subsequent earnings instability - is inconsistent with a double 'A' ('AA') category rating. Samsung's 'A' category credit profile is clearly supported by its technology leadership, dominant market positions, and a well-diversified business portfolio, which help to mitigate earnings fluctuations to a certain extent. However, the volatility inherent in its core operations, particularly the cyclicality of its semiconductor and display panel businesses - as well as the rapidly changing fortunes of global handset manufacturers - remain significant risks that are not commensurate with a 'AA' category rating.

Thin operating margins versus other Fitch-rated tech companies in the 'A' and 'AA' categories is another factor. In the case of Microsoft, its operating margins have been consistently higher than 40% over the past five years, well above Samsung's five-year average of 8.6% and its recent 9M12 high of 14%.

Notably, other US tech companies rated by Fitch in the single 'A' category - including IBM, eBay, Texas Instruments and Oracle -- boast operating margins above 20%.

Another important factor is the capital-intensive nature of Samsung's operations, being a hardware-oriented company. Capex has drained an average 86% of its annual cash flow from operations over the past five years. Consequently, free cash flow margins post-dividend payments have rarely been positive, in contrast with Microsoft's 20%-30% range over the past five years.

Fitch does not expect Samsung's highly capital-intensive nature to change very much. Rising competition from China is just one reason why substantial capex and R&D outlays will remain essential for the company to maintain its technology and market leadership across its major business lines - including its mobile handset division, which is currently responsible for almost 70% of overall operating profit.

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