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The latest on Samsung and the contrast between the pound and FTSE

14 October 2016

What’s happened to Samsung and can it recover?

On the 19th August Samsung released its acclaimed new smartphone model: the Galaxy Note 7. Within a week, reports emerged of the new phone overheating, exploding or catching fire due to battery issues. Samsung announced a voluntary recall of 2.5 million handsets, offering refunds or replacements to all affected customers. After the replacement Note 7’s continued to experience similar problems, Samsung had no choice but to cease all sales and halt production of the model. Since the phone’s final recall, Samsung’s share price has fallen 10%.

For Samsung, the implications of this blunder, at least in the short term, will be severe. The recall of millions of units, months of wasted production and an enormous amount of lost sales will likely cost Samsung in the billions. But the damage done may be considerably greater than this figure. Samsung is the world’s largest Smartphone manufacturer by number of units and with fierce competition in this field, the Apple iPhone 7 and Google Pixel were both just launched, this position may be forfeited as a result of the debacle. This comes at a particularly bad time ahead of the Christmas selling season.

In situations like this, the effect on big companies’ brand and reputation is often more important than the financial fallout. In competitive industries such as this, a severe slip-up can induce widespread loss of confidence from consumers and affect business in the long run. Thus, it is vital to react to these events in the best way possible to mitigate this.

The most renowned example is Johnson & Johnson (J&J) 30 years ago, which had a corporate crisis when tampering with their product, Tylenol, led to seven deaths. Through immediate acceptance of full accountability, putting consumer wellbeing first and then offering huge discounts to win back consumers in the aftermath, J&J’s share price and reputation recovered within a year. In fact, its management was even praised for its response. Samsung did put consumer wellbeing first by recalling the product, but it initially blamed suppliers and failed to accept full responsibility. The coming months will determine the effect of the crisis on the business, but the Korean firm will certainly have to fight hard to win back consumers in this already competitive market.

Why are the pound and the FTSE going in different directions?

There has been a stark contrast between the performance of the pound and the FTSE 100 over recent months. The pound has tumbled to a 30-year low against the dollar, whereas the FTSE has soared to new highs. Why is this the case?

There are pros and cons of a weaker pound to businesses. The disadvantages are that it makes importing more expensive, because the same pounds buy less foreign goods and this can compress profit margins. As the UK is a net importer (it imports more than it exports), this can have a considerable effect on the profits of UK firms and on market sentiment. In addition, the currency move brings with it a great deal of uncertainty. This has the capacity to put off investment and further inhibits earnings growth for UK firms.

However, over two thirds of earnings of the FTSE 100 come from overseas. Since these companies report in sterling terms, the value of their profits automatically increases when the pound weakens. Given that investors base their analysis on current and future earnings; this often leads to boosted share prices of companies with principally foreign revenues when the domestic currency weakens. Furthermore, exporters in the UK benefit from their goods being more internationally competitive when the pound declines and can profit accordingly. This may, in part, help to explain why the FTSE 100 has performed so well recently despite the dramatic fall in sterling.

The FTSE 250, which is far more domestically focused than the FTSE 100, has also performed strongly, up 4% since pre-Brexit. One would expect a collapse in this index in the face of a weaker pound due to revenues being primarily in pounds. In this case, the market has been supported by Bank of England action. A base rate decrease in August, for the first time in seven years, and a possible further cut before the end of the year have encouraged investors away from fixed income investments and towards higher-yielding equities. Whether this index can hold up in the face of a deteriorating domestic economy remains to be seen and to a large extent will depend on the actions of Theresa May and her new cabinet. 

 

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