Samsung Electro-Mechanics

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1 Asia Pacific/South Korea Equity Research Electronics Manufacturing Services Samsung Electro-Mechanics Rating OUTPERFORM Price (14-Jun-17, W) 85,1 Target price (W) (from 78,6) 12, Upside/downside (%) 41. Mkt cap (W/US$ bn) 6,356 / 5.66 Enterprise value (W bn) 8,82 Number of shares (mn) Free float (%) wk price range (W) 86,1-45,35 ADTO-6M (US$ mn) 3.7 Target price is for 12 months. Research Analysts Share price performance Sang Uk Kim sang.kim@credit-suisse.com Keon Han keon.han@credit-suisse.com The price relative chart measures performance against the KOREA SE KOSPI IDX which closed at 2, on 14/6/17. On 14/6/17 the spot exchange rate was W1,123.71/US$1 Performance 1M 3M 12M Absolute (%) Relative (%) (915.KS / 915 KS) ASSUMING COVERAGE Earnings recovery still underestimated Assuming coverage with OUTPERFORM. We assume coverage of Samsung Electro-Mechanics (SEMCO) with an OUTPERFORM rating (unchanged) and a W12, target price (W78,6 previously). SEMCO is a manufacturer of core IT components such as camera modules (~48% of FY17 sales), and passive components such as Multilayer Ceramic Capacitors or MLCCs (~33%) and substrates/packaging (~19%). We like SEMCO due to its better margin outlook for FY18, led by accelerating dual-camera supply, MLCC tightness, and cost control at matured items amid improving product mix. Still at an early stage of recovery. SEMCO's operating profit margin (OPM) appears well placed to recover in FY18E (6% vs %/4% in FY16/17) as (1) its dual-camera shipments will likely take a leap SEC's initial adoption could trigger a rapid penetration of dual-camera into global Android-based smartphones; the penetration will likely rise to 2-25% by FY18 (vs ~4% in FY16). We see SEMCO's dual-camera total addressable market expanding from 2H17 as: dual-cameras will be available in SEC's high-end smartphones; SEMCO now has more clients among China handset OEMs; and spec upgrades will likely take place in SEC's mid-/low-end smartphones in the long term. We believe MLCC ASPs remain favourable due to tight supply, particularly for high-end smartphones, and cost control takes effect at substrates with a better product mix (i.e., RF-PCB, and SLP). Catalysts. We view the likely adoption of dual-camera on the Galaxy Note 8 in 2H17 with 2H16 being a low base due to GN7 issues as a near-term driver, while rising dual-camera penetration at global smartphones and diversification of MLCC applications (i.e., autos), along with margin recovery at substrates, would be long-term catalysts. Valuation. We forecast operating profit of W287 bn/w58 bn in FY17/18 (7%/25% higher than consensus) with OPM assumptions of 4%/6% (vs % in FY16). Our TP of W12, is based on a high-cycle average P/B of 2.2x to FY17E BVPS on ROE expansion (4%/8% in FY17E/18E vs % in FY16). Key risks: Any delay in dual-camera adoption at SEC, irrational MLCC capacity expansion among peers, and mis-execution of restructuring at substrates. Financial and valuation metrics Year 12/16A 12/17E 12/18E 12/19E Revenue (W bn) 6,33. 6, , ,486.4 EBITDA (W bn) ,33.4 1, ,419.4 EBIT (W bn) Net profit (W bn) EPS (CS adj.) (W) 19 2,25 4,39 5,184 Change from previous EPS (%) n.a. (28.9) Consensus EPS (W) n.a. 2,29 3,578 4,195 EPS growth (%) (95.5) 1, P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) Source: Company data, Thomson Reuters, Credit Suisse estimate DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Focus charts Figure 1: Camera growth in terms of sales and OPM Wbn 4,5 4, 3,5 3, 2,5 2, 1,5 1, 5 1) Blended ASP rise on dual-cam 2) Leverage effect on TAM expansion(mid/low-end or China) E 218E 219E Camera modules sales OPM (%, RHS) Figure 3: MLCC OPM to rise on potential ASP hikes US$ % 5.% 4.% 3.% 2.% 1.%.% -1.% 4% 3% 2% Figure 2: SEMCO's dual-cam era has just begun mn units E 218E 219E Single-cam shipments Dual-cam shipments % of dual-cam to total C.M shipments (RHS) Figure 4: SEMCO MLCCs sales, and % of sales from the non-it segment Wbn 3,5 3, 2,5 6% 5% 4% 3% 2% 1% % 25% 2% % % -1% 2, 1,5 15% 1%.4.2-2% -3% 1, 5 5%. 1Q6 1Q7 1Q8 1Q9 1Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18E -4% E 218E 219E % MLCC ASP MLCC ASP YoY (%, RHS) SEMCO - MLCC OPM (%, RHS) MLCC sales % of MLCC sales from General industry/autos (RHS) Figure 5: Cost cutting/better mix to shrink losses at ACI Wbn 1,8 2% 1,6 % 1,4-2% 1,2-4% 1, -6% 8-8% 6-1% 4-12% 2-14% -16% E 218E 219E HDI BGA(FC-CSP) FC-BGA OPM(%, RHS) Figure 7: Ongoing ROE recovery to drive rerating X 4. 25% 3.5 2% 3. 15% 2.5 1% % 1. %.5-5%. -1% SEMCO 1yr fwd P/B(X) SEMCO rolling ROE (RHS) Source: Wisefn, company data, Credit Suisse estimates Figure 6: RF-PCB/SLP to drive HDI margin recovery Wbn 18 1% 16 % 14-1% % 8-3% 6-4% 4-5% 2-6% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17E3Q17E4Q17E1Q18E2Q18E3Q18E4Q18E HDI sales OPM (%, RHS) Figure 8: 12M implied P/E (x) suggests more upside X W 6. 18, 5. 16, 14, 4. 12, 3. 1, 2. 8, 6, 1. 4,. 2, Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 SEMCO - 12m - Implied PER(x) SEMCO - share px(rhs) Source: Wisefn, company data, Credit Suisse estimates Samsung Electro-Mechanics (915.KS / 915 KS) 2

3 Assuming coverage with OUTPERFORM Dual-cam adoption at SEC and rising utilisation driving OPM expansion MLCC ASPs remain healthy throughout 217 Trough seems over at ACI on cost cutting and mix improvement due to new technologies Ongoing earnings upgrades to ease concerns about valuation, particularly for FY18E Earnings recovery still underestimated We assume coverage of Samsung Electro-Mechanics (SEMCO) with an OUTPERFORM rating (unchanged) and a W12, target price (W78,6 previously). SEMCO is a manufacturer of core IT components such as camera modules (48% of FY17 sales), and passive components such as MLCCs (33%) and substrates/packaging (19%). We like SEMCO for its better margin outlook, led by accelerating dual-camera supply, favourable MLCC pricing amid supply tightness, and lower cost of matured items on improving mix. DM: Margin expansion on dual-cam/higher utilisation Digital Module division: SEMCO's dual-cam shipments will likely take a leap SEC's initial adoption to trigger a rapid penetration of dual-cam into global Android-based smartphones. We see SEMCO's dual-cam total addressable market (TAM) expanding from 2H17, as: (1) dual-cams will be available in SEC's high-end smartphones; (2) SEMCO now has more clients among China handset OEMs; and (3) spec upgrades should take place in SEC's mid-/low-end smartphones in the long term. We believe dualcam penetration into global smartphones will rise to 2-25% by FY18 (vs ~4% in FY16). LCR: MLCC pricing to remain favourable Linkage of Magnetic Flux Coil, Capacitor, Resistor (LCR) division: MLCC ASPs remain favourable due to tight supply, particularly for high-end embedded solutions for smartphones. Besides, the upcoming iphone 8 cycle could exacerbate the supply tightness to support higher MLCC margins in 2H17 both from ASP hikes and higher-than-usual volume growth. We expect SEMCO's MLCC OPM to reach mid-teen percentage in 2H17 and positive momentum should continue into 1H18, thanks to the commencement of SEC's next flagship smartphone components build-up cycle. The ongoing spec upgrades at China smartphone vendors also continue to result in a tighter MLCC supply condition, in our view. ACI: The worst cycle is behind us Advanced Circuit Interconnect (ACI) division: Cost control takes effect at the substrates business amid a better product mix, which should lift margins i.e., Rigid-Flex PCB (RF-PCB), and Substrates Like PCB (SLP). We believe the worst cycle for HDI is over, given a reduced cost base (Vietnam fab operation starts) and rising demand on RF- PCB, which is triggered by AAPL's first OLED panel adoption at iphones. Meanwhile, SEC's potential adoption of SLP in its flagship smartphones in FY18E should continue to raise utilisation, which would support operating loss contraction on HDI. For BGA (FC- CSP), sales could at least show a flattish trend for a while on rising in-house AP (Exynos) adoption at SEC's mid-/low-end smartphones, albeit the ongoing technology shift towards FO-WLP or FO-PLP (wafer-level or panel-level packaging vs chip-scale). Earnings upgrades to ease concerns about valuation We forecast OP of W287 bn/w58 bn in FY17/18 (7%/25% higher than consensus) with OPM assumptions of 4%/6% (vs % in FY16). Our TP of W12, is based on a highcycle average P/B of 2.2x to FY17E BVPS on ROE expansion (4%/8% in FY17E/18E vs % in FY16). We believe earnings upgrades acceleration will gradually alleviate investor concerns about valuation, particularly for FY18E. We view the adoption of dual-cam on the Galaxy Note 8 in 2H17 with 2H16 being a low base (GN7 issues) and higher MLCC margins as near-term catalysts, while rising dual-cam penetration at global smartphones, coupled with MLCC application diversification (i.e., autos) as well as better-mix at substrates, would be long-term catalysts. The key risks are delay in dual-cam adoption at SEC, irrational MLCC capacity expansion among peers, and mis-execution of restructuring at substrates or poor yield rates at the FO-PLP business at the initial stage. Samsung Electro-Mechanics (915.KS / 915 KS) 3

4 Samsung Electro-Mechanics (915.KS / 915 KS) Price (14 Jun 217): W85,1; Rating: OUTPERFORM; Target Price: (from W78,6) W12,; Analyst: Sang Uk Kim Income Statement (W bn) 12/16A 12/17E 12/18E 12/19E Sales revenue 6,33 6,916 8,42 9,486 Cost of goods sold 5,6 5,465 6,494 7,31 EBITDA 633 1,33 1,294 1,419 EBIT Net interest expense/(inc.) Recurring PBT Profit after tax Reported net profit Net profit (Credit Suisse) Balance Sheet (W bn) 12/16A 12/17E 12/18E 12/19E Cash & cash equivalents ,76 Current receivables 784 1,75 1,31 1,472 Inventories 827 1,134 1,382 1,552 Other current assets Current assets 2,812 3,433 4,2 4,597 Property, plant & equip. 3,714 3,572 3,674 3,733 Investments Intangibles Other non-current assets Total assets 7,663 8,343 9,172 9,959 Current liabilities 2,43 2,85 3,377 3,81 Total liabilities 3,325 3,948 4,475 4,899 Shareholders' equity 3,967 4,65 4,367 4,73 Minority interests Total liabilities & equity 7,663 8,343 9,172 9,959 Cash Flow (W bn) 12/16A 12/17E 12/18E 12/19E EBIT Net interest Tax paid Working capital (48) (43) (325) (224) Other cash & non-cash items Operating cash flow ,16 1,232 Capex (1,52) (92) (87) (87) Free cash flow to the firm (372) (112) Investing cash flow (1,186) (993) (962) (962) Equity raised 2 Dividends paid (41) (44) (44) (45) Financing cash flow (26) Total cash flow (225) (3) Adjustments Net change in cash (225) (3) Per share 12/16A 12/17E 12/18E 12/19E Shares (wtd avg.) (mn) EPS (Credit Suisse) (W) 19 2,25 4,39 5,184 DPS (W) Operating CFPS (W) 9,99 1,828 13,67 16,499 Earnings 12/16A 12/17E 12/18E 12/19E Growth (%) Sales revenue (2.3) EBIT (91.9) EPS (95.5) Margins (%) EBITDA EBIT Valuation (x) 12/16A 12/17E 12/18E 12/19E P/E P/B Dividend yield (%) EV/sales EV/EBITDA EV/EBIT ROE analysis (%) 12/16A 12/17E 12/18E 12/19E ROE ROIC Credit ratios 12/16A 12/17E 12/18E 12/19E Net debt/equity (%) Net debt/ebitda (x) Source: Company data, Thomson Reuters, Credit Suisse estimates Company Background Samsung Electro-Mechanics Co., Ltd. manufactures a variety of electronic components used in computers, audio/ video products, industrial electronics, and telecommunication equipment. Blue/Grey Sky Scenario Our Blue Sky Scenario (W) (from 96,5) 175, Our blue sky scenario assumes (1) higher-than-expected dual camera average selling price from Samsung Electronics; (2) faster China penetration and (3) higher-than-expected passive components pricing such as Multi-Layer Ceramic Capacitors (MLCCs) Our Grey Sky Scenario (W) (from 48,5) 67, Our grey sky scenario assumes (1) delay in dual camera adoption at Samsung; (2) slower-than-expected China penetration; (3) aggressive MLCC capacity expansion among peers and (4) any misexecution in restructuring at Substrates and packing business such as PLP (Panel Level Packaging). Share price performance The price relative chart measures performance against the KOREA SE KOSPI IDX which closed at 2, on 14-Jun-217 On 14-Jun-217 the spot exchange rate was W1,123.71/US$1 Samsung Electro-Mechanics (915.KS / 915 KS) 4

5 Valuation summary Figure 9: Valuation comparison by major industry Mkt cap TP Price Up/ Company Ticker Rating CCY (US$mn) (local ccy) (local ccy) Down(%) E 218E E 218E E 218E Global camera modules (avg) 3% 16% 18% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% LG Innotek 117.KS OUTPERFORM KRW 3, , 154, 7% % 12% 11% Sunny Optical 2382.HK OUTPERFORM HKD 9, % 29% 38% 38% Lite-On 231.TW NEUTRAL TWD 3, % 12% 14% 14% O-Film 2456.SZ NEUTRAL CNY 6, % 1% 15% 18% Sharp 6753.T UNDERPERFORM JPY 17, % -23% 16% 16% Sony 6758.T OUTPERFORM JPY 46,763 4,7 4,6 16% 3% 12% 11% Q Tech 1478.HK NC HKD 851 n/a 6 n/a 14% 21% 23% Primax 4915.TW NC TWD 883 n/a 6 n/a n/a n/a n/a MCnex 9752.KQ NC KRW 179 n/a 22,25 n/a -32% 22% 26% Partron 917.KQ NC KRW 58 n/a 1,5 n/a 7% 1% 13% Cowell E 1415.HK NC HKD 256 n/a 2 n/a 1% 14% 15% Global passive components (avg) 1% 1% 1% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Murata 6981.T OUTPERFORM JPY 3,68 18,2 15,495 17% 13% 14% 14% Taiyo Yuden 6976.T NEUTRAL JPY 1,75 1, 1,632-39% 4% 5% 6% TDK 6762.T NEUTRAL JPY 8,54 8,5 7,42 15% 1% 1% 1% Yageo 2327.TW NC TWD 1,649 n/a 99 n/a 16% 16% 14% 2.3 n/a n/a 13.7 n/a n/a Walsin Tech 2492.TW NC TWD 872 n/a 51 n/a 15% 13% n/a 2. n/a n/a n/a Global PCB/PKG (avg) -6% 8% 11% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Kinsus 3189.TW NEUTRAL TWD 1, % 8% 7% 8% Unimicron 337.TW NEUTRAL TWD % -1% 1% 3% Ibiden 462.T UNDERPERFORM JPY 2,54 1,34 1,99-33% -21% 3% 3% Kyocera 6971.T NEUTRAL JPY 21,748 6,4 6,484-1% 4% 4% 5% Shinko 6967.T NEUTRAL JPY 1, % 2% 6% 7% AT&S ATSV.VI NC EUR 412 n/a 9 n/a -4% -3% 6%.7 n/a n/a n/a 13.1 n/a BH 946.KQ NC KRW 46 n/a 29,5 n/a -23% 3% 34% n/a Interflex 5137.KQ NC KRW 697 n/a 37, n/a -28% 14% 25% n/a Korea Circuit 781.KS NC KRW 331 n/a 15,6 n/a -2% 12% 13% n/a Daeduk GDS 413.KS NC KRW 329 n/a 17,9 n/a 2% 8% 9% n/a Overall (avg) 2% 11% 13% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Note: Priced as of 14 June 217. NC + Not covered. Source: Bloomberg consensus estimates (for Not Covered companies), company data, Credit Suisse estimates for covered companies ROE(%) PBR(X) PER(X) Figure 1: SEMCO customers/competitors summary Division / Product Major Customers (% of sales) Major Competitor Overall Samsung(>5% ), China(25% ), Others DM (Digital Module) Camera modules Samsung(65% ), China(3% ), Others Samsung In-house, Sunny Optic., Lite-on Tech, Primax, Sharp, LGI, Partron, MCnex Wireless solution (WiFi / Bluetooth modules / Battery charging ) Samsung(7% ), Apple(1% ), Others Amotek, Hansol Technics, RF Samsung LCR (linkage magnetic flux coil Capacitator Resistor) MLCC (Multi-layer Ceramic Capacitator) China(45% ), Samsung(3% ), AAPL(9% ), Others Murata, TDK(Auto) Taiyo Yuden, Yageo, Walsin EMC (Electro Magnetic Compatibility), Chip-Resistor Samsung Murata, TDK, Taiyo Yuden, KOA, ROHM ACI (Advanced Circuit Interconnect) HDI (High Density Interconnect) Samsung(75% ), Others Ibiden, Daeduck GDS, Korea Circuit, BH, Interflex, Kinsus, Unimicron, AT&S BGA (Ball Grid Array) QCOM(45% ), Samsung(4% ), Mediatek/Others Ibiden, Kinsus, Unimicron, LG Innotek, Kyocera FC-BGA (Flip Chip Ball Grid Array) Intel (>9% ) Ibiden, Shinko Electric, Unimicron Samsung Electro-Mechanics (915.KS / 915 KS)

6 Digital Module: Margin expansion on dualcam/higher utilisation Why camera module margins were depressed before? The DM (Digital Module) division represents about 48% of SEMCO's total sales in FY17E, and includes camera modules and wireless solutions as major products. Camera modules represent about 85% of the division's sales. The remaining 15% of product revenues mostly come from Wi-Fi/Bluetooth modules, and wireless battery charger, etc. SEMCO has been a key camera modules supplier to SEC's flagship smartphones, which have been experiencing resolution migration, particularly for rear camera. Nonetheless, SEMCO's earnings from camera modules have remained subdued since 213 given SEC high-end smartphones' lower-than-expected growth amid rising competition in the global smartphones industry while the de-leverage effect has been exacerbated by low utilisation rates due to heavy fixed cost investments since 21. Besides, a limitation on further resolution migration exacerbated ASP pressures (i.e., GS7 reduced camera specs to 12MP vs 16MP at GS6). Figure 11: SEMCO Digital Modules (DM) sales vs OPM trend Wbn 4,5 4, 3,5 3, 2,5 2, 1,5 1, E 218E Camera modules sales Wirelss Solutions sales OPM (%, RHS) 6.% 5.% 4.% 3.% 2.% 1.%.% -1.% Samsung Electro-Mechanics (915.KS / 915 KS) 6

7 Figure 12: SEC's flagship smartphone shipments vs SEMCO's camera module OPM Figure 13: SEMCO camera module utilisation vs OPM trend Wbn % 7% 4.5% % 3.5% 3.% 2.5% 65% 6% 4.% 3.5% 3.% 2.5% 9 2.% 55% 2.% % 1.%.5%.% 5% 45% 1.5% 1.%.5%.% % 4% % SEC's flagship smartphones OPM (%, RHS) Camera modules UTR (%) OPM (%, RHS) Note: 216 camera module utilisation increased slightly despite GN7 issues, given better sales in GS7, start of mid/low-end camera modules supply, and higher penetration into China. Margins to recover on dual-cam amid increasing UTR We expect SEMCO to deliver margin improvement in camera modules from FY17, led by (1) blended ASP hikes on rising dual-cam penetration, boosted by SEC's adoption of dualcam in its smartphones, and (2) operating leverage amid rising utilisation rates, driven by the expansion of its total addressable market into mid-/low-end smartphones at SEC, where cameras specs are being upgraded and SEMCO now has more China handset customers with a better option of supplying dual-cams (i.e., OPPO/Vivo, vs only Xiaomi previously). Figure 14: SEMCO's camera modules we expect growth in both sales and OPM Wbn 4,5 4, 3,5 3, 2,5 2, 1,5 1, E 218E 219E Camera modules sales 1) Blended ASP rise on dual-cam 2) Leverage effect on TAM expansion(mid/low-end or China) OPM (%, RHS) 6.% 5.% 4.% 3.% 2.% 1.%.% -1.% Blended ASP set to rise, led by SEC's dual-cam adoption in 2H17 We expect the blended ASP of SEMCO's dual-cam to increase as SEC's flagship smartphones are likely to adopt dual-cam starting with the Galaxy Note 8 in 2H17. We believe SEMCO will benefit further in 1H18, with rising dual-cam penetration into the new Galaxy S series. SEMCO could also enjoy better ASPs from China customers with dual- Samsung Electro-Mechanics (915.KS / 915 KS) 7

8 cam smartphones as well as from SEC's China-focused product line-up (i.e., Galaxy C1), which is reportedly having dual-cam (Samsung Galaxy C1 press images leak, confirm dual camera setup GSMarena, 12 Jun, link) In the long term, Samsung's mid-/low-end smartphone line-ups (Galaxy A or J series) are also likely to adopt dual-cam, presumably from late FY18E or in FY19E, given the ongoing hardware spec competition among peers, in our view. Figure 15: SEMCO blended ASP rising in line with dual-cam penetration (%) US$ E 218E 219E 6% 5% 4% 3% 2% 1% % Blended ASP($) % of dual-cam to total C.M shipments (RHS) Figure 16: Dual-cam penetration outlook in global smartphones Figure 17: SEMCO list of smartphones with potential adoption of SEMCO's dual-cam Mn units SEMCO's dual-cam client/expected models 217E 218E 1,75 25% SEC Galaxy Note 8 Galaxy S9 1,7 Galaxy C1 Galaxy S9 Plus 1,65 2% Galaxy Note 9 Xiaomi Mi 6 / Mi 6 Plus 1,6 OPPO R11 / R11 Plus 1,55 15% vivo V5 Plus 1,5 1,45 1% 1,4 5% 1,35 1, E 218E % Global smartphones Dual camera penetration (%, RHS) Source: GSMarena, company data, Credit Suisse research Operating leverage taking off on total addressable market expansion In addition to the blended ASP rise, we expect SEMCO's camera modules fab utilisation rates to gradually increase, driven by total addressable market (TAM) expansion into SEC's mid-/low-end smartphone line-up, where spec upgrades are ongoing, and into more China customers with an option of dual-cam supply. Natural capacity loss amid dual-cam transition should also help utilisation recovery, even if further dual-cam capacity expansion is considered. While we acknowledge that camera modules are a low value-added assembly business compared to the upstream (i.e., CMOS/Lens), rising utilisation should be taken as a key positive for margin expansion led by operating leverage effect. Samsung Electro-Mechanics (915.KS / 915 KS) 8

9 Furthermore, dual-cam is deemed to raise entry barriers on the camera assembly business, given the rising importance of Active Align between two lenses or moresophisticated packaging technologies for achieving slimmer form-factor. Figure 18: TAM expansion for SEMCO's camera modules driving utilisation increase mn units Figure 19: SEMCO's camera module shipments breakdown vs utilisation mn units % 8% 7% 6% 5% E 218E 219E China smartphone OEMs SEC - mid/low-end smartphones(a/j series) SEC - high-end smartphones(s/n series) E 218E 219E SEMCO - C.M supply to China customers SEMCO - C.M supply to SEC's mid/low-end smartphones SEMCO - C.M supply to SEC's high-end smartphones Camera module UTR(%, RHS) 4% Note*: For China, only Xiaomi, OPPO and vivo smartphone shipments are considered.. Figure 2: Rising utilisation to drive margin expansion Figure 21: Camera modules cost breakdown 9% 6.% 8% 5.% 7% 4.% Others 24% CMOS 34% 3.% 6% 2.% 5% 1.% Lens 25% Other semiconductor 17% 4% E 218E 219E.% Camera Modules UTR(%) C.M - OPM(%, RHS) Note: As of FY16. Source: Company data, Credit Suisse research In its camera modules business, SEMCO expects to generate ~W8 bn in sales from its China handsets clients up ~13% YoY and ~25% of total camera modules sales in FY17E. We believe visibility is high, given the ongoing customer diversification in China smartphone markets, leveraged by rising higher ASP dual-cam supply. Samsung Electro-Mechanics (915.KS / 915 KS) 9

10 Figure 22: SEMCO camera modules business sales from China Figure 23: Camera modules sales breakdown by customer (217E) Wbn 1,6 1,4 1,2 4% 35% 3% Others 5% 1, 8 25% 2% China 3% % 1% 5% SEC 65% E 218E 219E Sales from China handset clients % of total SEMCO camera modules sales % Samsung Electro-Mechanics (915.KS / 915 KS) 1

11 LCR is the most profitable division of SEMCO currently LCR: MLCC pricing to remain favourable The Linkage of Magnetic Flux Coil, Capacitor, Resistor (LCR) division contributes about 33% to SEMCO s total sales in FY17E, and is currently the most profitable division. MLCCs (Multi-Layer Ceramic Capacitors) represent about 9% of the division's sales. The remaining 1% of product revenues mostly come from the Chip Inductors or Chip Resistors. Over the years, SEMCO has improved the quality of its MLCCs and is now ranked the second biggest MLCC player globally. Its key competitors include Murata, Taiyo Yuden, TDK, and Yageo. In terms of customer mix, various China clients (i.e., PC/mobile, etc) account for ~45%, followed by SEC (~3%), and AAPL (~9%). Figure 24: MLCCs global market share trend (sales) Figure 25: SEMCO MLCC sales mix, by client 5% 45% 4% 35% 3% 25% 2% 15% AAPL 9% Others 16% China 45% 1% 5% % SEC 3% Murata SEMCO Taiyo Yuden TDK Yageo AVK Kyocera Source: Company data, Credit Suisse research MLCC price trajectory is likely on a positive trajectory in YoY terms in 2H17E Note: As of FY17E. iphone 8 cycle amid tight supply raising OPM We are of the view that MLCC ASPs remain favourable due to tight supply, particularly for high-end embedded solutions for smartphones. Besides, the upcoming iphone 8 cycle could exacerbate the supply tightness, which will likely support higher MLCC margins in 2H17 both from ASP hikes and higher-than-usual volume growth. We expect SEMCO's MLCC OPM to reach a mid-teen percentage in 2H17, and positive momentum could continue into 1H18, thanks to SEC's next flagship smartphone components build-up cycle. The ongoing spec upgrades at China smartphone vendors also continue to result in tighter MLCC supply conditions, in our view. Samsung Electro-Mechanics (915.KS / 915 KS) 11

12 Figure 26: SEMCO LCR sales trend (MLCC/Inductors) vs OPM Wbn 4, 3,5 3, 2,5 2, 1,5 1, E 218E 219E MLCCs sales EMC(Chip Inductors etc) sales OPM(%, RHS) 12% 1% 8% 6% 4% 2% % MLCC supply to remain tight throughout 217 or even in 218 According to our Japan analyst covering Murata (Akinori Kanemoto, Full report), MLCC supply is unexpectedly tight. Taiwanese and some Japanese makers have raised their prices, giving rise to the view that supply will remain tight next year. Some, mostly major customers, have started to indicate they are prepared to accept higher prices. Digitimes also reported on 7 June 217 (click) that SEMCO's competitors appear to be making efforts to raise MLCC ASP. Yageo will reportedly adjust upward its MLCC prices to reflect its tight supply, and Walsin Technology is also expected to follow suit. Under the same context, SEMCO is well placed to benefit from a potential price-hike in 2H17, which will drive its MLCC OPM expansion. When it comes to global MLCC supply, since 213, MLCC industry supply growth has been limited under 1% YoY while utilisation rates have remained over 9%. Particularly, TDK's decision to concentrate on Automotive MLCCs at the expense of discontinuation of handset MLCCs appears to have worsened the supply situation, in particular for high-end smartphones where MLCCs volumes and mix are continuously upgraded. TDK in mid- 216 announced it would gradually phase out from the general-type MLCC segment and put increased focus on specific high-margin sectors. Samsung Electro-Mechanics (915.KS / 915 KS) 12

13 Figure 27: MLCC peers relative stock performance time for high-end MLCC players to catch up (vs mid-/low-end: Yageo/Walsin) 1 Jan 216 = SEMCO Murata Taiyo Yuden TDK Yageo Walsin Source: Thompson Reuters Datastream, Credit Suisse research Figure 28: MLCC ASP YoY vs SEMCO MLCC OPM (%) trend US$ Q6 1Q7 1Q8 1Q9 1Q1 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18E 4% 3% 2% 1% % -1% -2% -3% -4% MLCC ASP MLCC ASP YoY (%, RHS) SEMCO - MLCC OPM (%, RHS) Samsung Electro-Mechanics (915.KS / 915 KS) 13

14 Figure 29: Major top 5 MLCC capacity (monthly) Figure 3: MLCC capacity YoY vs UTR (%) trend bn units/mon 3 3% 1% 3% 95% 25 25% 9% 25% 2 2% 85% 2% 8% 15 15% 75% 15% 1 1% 7% 65% 1% 5 5% 6% 5% % 55% 5% E % Yageo SEMCO TDK Taiyo Yuden Murata YoY (%, RHS) Average MLCC Utlization (%) YoY (%, RHS) In addition to supply constraints, SEMCO's new Philippine MLCC plant yield has improved significantly during 1Q17 post the ramp-up difficulty during the prior quarter. This plant will only produce high-end MLCC where 5% increase in total capacity is expected to drive up MLCC sales incrementally by >2% in FY17E. iphone 8 component build-up drives high-end MLCCs ASP hikes in 2H17 We expect a major upgrade for MLCCs the first since 213 models. More MLCCs will be needed due to the shift to 1nm application processors, and the adoption of nextgeneration MLCCs models should also lift the average unit price. We estimate the number of MLCCs per device will increase from 8 in the iphone 7 to over 1, in the iphone 8. There is also likely to be a shift to more compact large-capacity devices, with 1uF MLCC dropping from size 15 to size 63, and 47uF declining from size 168 to size 15. In the iphone 7, AAPL switched from single-core to dual-core architecture, spurring a large increase in the number of power inductors per device. However, there is unlikely to be similar growth with the iphone 8, as it will also use a dual core application processor. Samsung Electro-Mechanics (915.KS / 915 KS) 14

15 Figure 31: MLCC count iphone 8 vs 7 per unit Figure 32: SEMCO's MLCC market share at AAPL #s of MLCCs per device SEMCO 9% Others 6% 6 4 Taiyo Yuden 25% Murata 6% 2 iphone 8 iphone 7 iphone 8 iphone 7 Note: As of FY17E. Bull-case scenario analysis on MLCC ASP/OPM Given potential MLCC price hikes from 2H17E, we believe there could an upside risk to our base-case MLCC earnings forecasts. On an annualised basis, we see 1%/2% MLCC ASP YoY declines with 12%/12% OPM in FY17E/18E. However, our bull-case scenario analysis suggests that there could be 9%/16% upside potential to SEMCO's total OP in FY17E/18E should MLCC ASP end up going up by 1%/1% with 13%/14% OPM generation in FY17E/18E. Figure 33: MLCC OP forecasts base case Wbn, % 217E 218E MLCC Sales 2,54 2,75 MLCC ASP (YoY, % ) -1% -2% MLCC OP MLCC OPM(% ) 12% 12% Total Sales 6,916 8,419 Total OP Figure 34: MLCC OP forecasts bull case Wbn, % 217E 218E MLCC Sales 2,97 2,844 MLCC ASP (YoY, % ) 1% 1% MLCC OP MLCC OPM(% ) 13% 14% Total Sales 6,959 8,558 % of Sales upside 1% 2% Total OP % of OP upside 9% 16% Source: Credit Suisse estimates Source: Credit Suisse estimates Samsung Electro-Mechanics (915.KS / 915 KS) 15

16 Efforts for MLCC application diversification continue SEMCO s MLCC business has been driven by handset industry growth and it is still the most crucial market for the company. However, the MLCC industry continues to grow from end-market application diversification. The segment that is growing most rapidly is the automotive industry, which averages about ~2% of industry demand. Communications devices continue to average about a third of industry demand. SEMCO also keeps making efforts to expand its addressable market towards non-telecoms related items, such as autos or general industry, which currently occupy ~1% of total MLCC sales at the company. Figure 35: MLCC sales composition by application 6% Figure 36: MLCC sales index by application (4Q7 = 1). Auto-MLCC demand rapidly growing 3 5% 25 4% 2 3% 15 2% 1 1% 5 % 1Q1 4Q1 3Q11 2Q12 1Q13 4Q13 3Q14 2Q15 1Q16 4Q16 AV PC Handset Automotive Others AV PC Telecom equip Auto Note 4Q7 = 1. Source: Company data, Credit Suisse research We are of the view that the possibility for SEMCO to gain market share in non-handset MLCCs is becoming higher. MLCC supply seems tight for all applications, not just for smartphones, including autos. Hence, there could be a possibility for SEMCO to gain more share in this market where Japanese players, such as Murata, TDK and Taiyo Yuden currently dominate. Of note, some of SEMCO's tier 1 auto clients seem to have begun using its products that they previously declined to use. Samsung Electro-Mechanics (915.KS / 915 KS) 16

17 Figure 37: SEMCO MLCCs sales, and % of sales from the non-it segment Wbn 3,5 25% 3, 2,5 2, 2% 15% 1,5 1, E 218E 219E 1% 5% % MLCC sales % of MLCC sales from General industry/autos (RHS) Auto-MLCC demand rising in auto-electrification As we highlighted in our automotive-tech primer in June 216 (click), MLCCs may contribute to greater use of electronics, such as in self-driving cars. The value of MLCCs per vehicle has been rising at 1% p.a. The market leader, Murata has been one of the key beneficiaries, led by better mix on higher volumes of Engine Control Units (ECUs) and greater use of value-added ECUs for direct injection applications and the like. Demand has also risen for 2 o C-rated MLCCs as ECUs are installed near the engine room and vehicles increasingly feature power packs. Furthermore, MLCCs demand in infotainment and V2X Wi-Fi modules also appears to be rising where SEMCO could have a better chance to penetrate, in our view. In general, automotive MLCCs command ASP premium over other applications, thanks to a higher entry barrier for safety requirement; we do believe SEMCO's potential market share gains in the global auto-mlcc market will boost its MLCC OPM even higher towards the level of Murata in the long term. Samsung Electro-Mechanics (915.KS / 915 KS) 17

18 Figure 38: Automotive MLCC market Figure 39: Automotive MLCC ASP per vehicle US$mn 1,4. US$ 16. 1,2. 1,. CAGR +14% (FY3/3 to FY3/17) CAGR +1% (FY3/3 to FY3/17) Automotive MLCC market size Average MLCC ASP per car Figure 4: Automotive MLCC global market shares Figure 41: MLCC OPM(%) trend by players Automotive 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % TDK Taiyo Yuden Murata Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Samsung Electro-Mechanics (915.KS / 915 KS) 18

19 ACI: The worst cycle is behind us The Advanced Circuit Interconnect (ACI) division contributes about 19% to SEMCO s total sales in FY17E. Core ACI products include High Density Interconnects (HDI), which are the main boards used in handset fabrication. Ball Grid Array (BGA) mainly consists of Flip Chip Chip Scale Package (FC-CSP) where SEMCO provides the substrates for packing basebands (BB) and Application Processors (A/P). Flip Chip BGA (FC-BGA) consists of packaging substrate for mainly CPUs and PC-related chipsets. The division s key customers are SEC, APPL, QCOM, and INTC, while SEMCO competes with Ibiden, Korea Circuit, BH, Interflex, Kinsus, Shinko, among others, for the substrates as well as chip packaging business unit. We are of the view that cost control will take effect at the ACI division amid better product mix, which will drive margin recovery i.e., RF-PCB, Substrates Like PCBs (SLP). We believe the worst cycle of HDI is behind us, given lowered labour costs (Vietnam fab operation starts) and rising demand on Rigid-Flex PCB, which is triggered by AAPL's first OLED panel adoption at iphones. Meanwhile, SEC's potential adoption of SLP at its flagship smartphones in FY18E would continue to raise utilisation rates, which would support operating loss contraction on HDI. For BGA (FC-CSP), sales could at least show a flattish trend for a while led by rising in-house AP (Exynos) adoption at SEC's mid/low-end smartphones despite ongoing technology shift towards FO-WLP or FO-PLP (wafer level or panel level packaging vs chip-scale) Figure 42: SEMCO ACI divisional sales vs OPM trend Wbn 1,8 1,6 1,4 1,2 1, E 218E 219E HDI BGA(FC-CSP) FC-BGA OPM(%, RHS) 2% % -2% -4% -6% -8% -1% -12% -14% -16% Cost cutting amid better mix to drive margin recovery HDI: Trough is over on rising UTR at Vietnam with new product cycle We believe the worst cycle for HDI is now behind us, led by SEMCO's continuous efforts at reducing costs as well as upcoming product-mix improvement opportunities, thanks to AAPL's higher RF-PCB adoption via OLED panel usage in 2H17E or SEC's SLP adoption for its upcoming flagship smartphone, Galaxy S9, in FY18E. With a lowered cost base, the operating leverage effect through utilisation recovery and blended ASP improvement should drive operating loss contraction from 2H17E to 218E, in our view. The company aims to reduce HDI losses to about -W6 bn in FY17E (vs more than -W12 bn in FY16). Samsung Electro-Mechanics (915.KS / 915 KS) 19

20 Vietnam relocation completed; time for UTR improvement with a low cost base It took nearly two years for SEMCO to move HDI production out of Korea to China and then eventually to Vietnam. During this time, Samsung smartphones' total volumes did not grow much rather, the demand for high-end HDI declined compared to the rise in volume of mid-/low-end smartphones. The worsened mix and relocation costs led to a sharp operating loss from 2H15. It was a big investment to construct the Vietnam plant near Samsung's new smartphone production site. HDI production in Vietnam is expected to rise by 5x during FY17E, marking the beginning of operational efficiency. Figure 43: SEMCO HDI quarterly sales and OPM trend (since 1Q15) Wbn Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17E 3Q17E 4Q17E 1Q18E 2Q18E 3Q18E 4Q18E 1% % -1% -2% -3% -4% -5% -6% HDI sales OPM (%, RHS) New technology adoption at AAPL/Samsung to drive loss contraction In addition to cost reduction, we expect SEMCO's HDI to benefit from new technology adoption at key clients such as AAPL in 2H17 (RF-PCB at iphone 8) and Samsung in 218E (SLP at new Galaxy S or Note series), which could both lead to utilisation improvement and blended ASP increase. For AAPL, the upcoming iphone 8 is likely to adopt OLED panel for its highest-end model from Samsung Display. SEMCO is expected to supply RF-PCBs for this as the second vendor followed by BH (946.KQ). RF-PCB is a Rigid-Flexible PCB, which is developed in response to rising demand on miniaturisation equipped with multiple functions. Samsung Electro-Mechanics (915.KS / 915 KS) 2

21 Figure 44: iphone 8 Pro (OLED) shipments outlook Figure 45: RF-PCB suppliers for iphone 8 Pro mn units Interflex 25% BH 4% SEMCO 35%. 4Q17E 1Q18E 2Q18E 3Q18E 4Q18E iphone 8 Pro Note: As of FY17E. In addition, there is rising possibility that Samsung's new flagship smartphones in FY18E might newly adopt Substrate Like PCBs (SLP), which AAPL will adopt for its new iphone series. AAPL's iphone 8 is likely to adopt SLP to reduce the area size of the mainboard, but which will offer a complicated circuit design. We believe the OLED iphone will be using two small SLPs vs one SLP for its LTPS models. If SEC's new Galaxy S or Note series starts adopting SLP in FY18E, SEMCO should be well placed to benefit from market share gains amid lesser PCB suppliers and blended ASP rise at HDI. The SLP supply chain could be integrated into four companies SEMCO, Korea Circuit (781.KQ), Daeduck GDS (413.KQ) and Ibiden from the existing fragmented HDI suppliers (6-7 players). Figure 46: Potential changes in iphone mainboard Figure 47: Samsung's potential SLP supply chain Ibiden 1% SEMCO 3% Daeduck GDS 3% Korea Circuit 3% Source: Company data, Credit Suisse research Note: As of FY17E. Source: Credit Suisse estimates Samsung Electro-Mechanics (915.KS / 915 KS) 21

22 What if HDI OPM recovers to normalised levels before restructuring starts Given the rising utilisation rates at the Vietnam fab with a low cost base amid product-mix improvement, we assume a moderate pace of quarterly OP improvement for the HDI division from 2H17 into 218E. We currently assume -18% OPM in FY17E and +1% OPM in HDI in FY18E as our base-case on an annual average, which we believe is somewhat conservative. From 26 to 214, before the recent restructuring, normalised OPM of HDI was ~4%. Should the margin recovery occur earlier or more than expected from 2H17E, it could generate additional +8% upside to FY17E total OP and +4% upside to FY18E. Figure 48: HDI OP generation base case Wbn 217E 218E HDI - Sales HDI - OP OPM(% ) -18% 1% Total OP % of total OP nm 1% Figure 49: HDI OP generation bull case Wbn 217E 218E HDI - Sales HDI - OP OPM(% ) -14% 4% Total OP % of total OP nm 4% OP upside (%) under bull-case 8% 4% Figure 5: HDI annual sales and OPM since 26 Wbn Average OPM(%) since (4%) E 218E 219E 2% 1% % -1% -2% -3% -4% -5% HDI - Sales OPM(%, RHS) BGA: Rise in SEC's Exynos penetration to mid-/low-end smartphones as a silver lining FC-CSP (Flip Chip-Chip Scale Package) from SEMCO is mostly being used for A/Ps and basebands. Major customers are QCOM (45-5%), Samsung (4%), Mediatek/others (1-15%). Despite the technology paradigm shift towards FO-WLP (Fan Out Wafer Level Package), Samsung's intention to use more in-house mobile A/P (Exynos) into mid-/lowend smartphone line-ups could be a silver lining for a while on the FC-CSP business. FC-BGA: No further growth but will remain its cash cow business SEMCO historically has been invited into the supply chain about nine months after the CPU launch, but that gap has been narrowing to about six months as SEMCO has improved its quality product development time. One obvious disadvantage of being a lateentry supplier is that product mix tends to lag. The higher mix of substrates for older generation CPUs and also the initial opportunity for charging higher ASP have diminished, Samsung Electro-Mechanics (915.KS / 915 KS) 22

23 suppressing margins in the past. We do not view FC-BGA as a growth business for SEMCO, since it supplies to one dominant customer, is not the industry leader, and PC industry growth is weak. At best, FC-BGA will likely remain its cash-cow business with generation of low-single-digit percentage of OPM. Figure 51: TSMC's fan-out claims advantages over flip-chip Figure 52: TSV technology could be a potential risk to SEMCO's HDI business Source: TSMC, Credit Suisse research Source: Lam Research, Credit Suisse research Samsung Electro-Mechanics (915.KS / 915 KS) 23

24 Our FY17/FY18 OP estimates are 7%/25% higher than consensus Earnings upgrades to ease concerns about valuation Earnings forecasts We are of the view that SEMCO's earnings growth profile is becoming more constructive, and estimate OP of W287 bn/w58 bn in FY17E/18E with 4%/6% OPM assumptions (vs % in FY16). Top-line growth acceleration into FY18E (22% YoY vs 15% YoY in FY17E) will trigger an operating leverage effect through utilisation improvement, which should drive better profitability. Our FY17/18E OP estimates are currently 7%/25% higher than Bloomberg consensus estimates. Figure 53: SEMCO earnings forecasts (216-19E) (KRW bn) 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17E 3Q17E 4Q17E 1Q18E 2Q18E 3Q18E 4Q18E E 218E 219E Revenue 1,64.3 1, , , ,57.5 1,7. 1,81. 1, ,83.8 2, , , ,33. 6, , ,486.4 DM ,34.4 1,95.9 1,81.6 2, , ,4.7 4,717.5 LCR , , , ,36.2 ACI ,316. 1,36.7 1, ,368.7 Operating Profits OPM(%) 3% 1% 1% -3% 2% 4% 5% 5% 5% 7% 6% 6% % 4% 6% 6% [OPM(%) by division] DM 2% 1% 2% % 3% 4% 5% 4% 4% 5% 5% 4% 1% 4% 5% 5% LCR 1% 1% 8% 1% 8% 11% 13% 13% 11% 12% 11% 1% 8% 11% 11% 11% ACI -7% -16% -14% -19% -13% -6% -7% -4% -3% -2% % 1% -14% -7% -1% 1% Revenue breakdown by division 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17E 3Q17E 4Q17E 1Q18E 2Q18E 3Q18E 4Q18E E 218E 219E Revenue 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% DM 43% 45% 45% 43% 49% 49% 47% 45% 44% 49% 49% 48% 44% 48% 48% 5% LCR 33% 31% 31% 33% 31% 31% 34% 35% 37% 34% 34% 34% 32% 33% 35% 35% ACI 22% 21% 22% 22% 19% 19% 19% 19% 18% 17% 17% 17% 22% 19% 17% 14% OP breakdown by division OP 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% 1% DM 32% 48% 13% -1% 76% 42% 42% 34% 33% 4% 39% 37% 143% 42% 38% 36% LCR 123% 344% 291% -9% 145% 85% 84% 82% 77% 65% 6% 6% 599% 89% 65% 61% ACI -55% -361% -365% 121% -149% -26% -26% -15% -1% -5% 1% 3% -743% -33% -2% 3% Figure 54: Sales outlook by division (216-19E) Figure 55: OP outlook by division (216-19E) Wbn Wbn 1, 7% 7 7% 9, 8, 7, 6, 5, 4, 3, 2, 1, E 218E 219E DM LCR ACI OPM(%, RHS) 6% 5% 4% 3% 2% 1% % E 218E 219E DM LCR ACI OPM(%, RHS) 6% 5% 4% 3% 2% 1% % Samsung Electro-Mechanics (915.KS / 915 KS) 24

25 Client mix continues to improve, thanks to China SEMCO has continued to make efforts to diversify its clients base by reducing earnings risk to the captive client, Samsung Electronics. Penetration into China customers has been paving the way for better client mix for SEMCO, and we believe sales contribution from China will likely reach ~25% by end-217. With rising demand on the high-end embedded MLCCs solution product along with the beginning of dual-cam supply, SEMCO's revenue generation out of China is well poised to grow further into FY18E, in our view. Figure 56: China sales continue to rise by hedging earnings risk to SEC Wbn 3,5 4% 3, 2,5 2, 1,5 1, 5 35% 3% 25% 2% 15% 1% 5% E 218E 219E % China sales % of total sales (RHS) Figure 57: Sales breakdown by major division 217E Figure 58: Sales breakdown by major customer 217E ACI 19% DM 48% Others 25% SEC 5% LCR 33% China 25% Note: As of 217E. Earnings sensitivity analysis Note: As of 217E. SEMCO likely continues to benefit from SEC's smartphone spec-upgrade (i.e., dual-cam), more penetration into SEC's mid-/low-end handsets, and securing more clients from China coupled with a better supply mix. We forecast that SEMCO should be able to generate ~US$2.5 of OP per one unit of SEC's high-end smartphone (S or Note series) by supplying dual-cam, high-end MLCC/Inductor, FC-CSP, HDI, Wi-Fi modules and wireless battery charger, etc. From SEC's mid-/low-end smartphones(a or J series), we believe Samsung Electro-Mechanics (915.KS / 915 KS) 25

26 SEMCO could generate US$.4 per device by providing rear-end single-cam, mid-end MLCC/inductor, etc. Lastly, from China handset OEMs, we believe SEMCO could create US$.3 per one unit by supplying MLCC and dual-cam or single-cam. Figure 59: SEMCO's OP generation per unit of SEC's high-end smartphone SEC: high-end smartphone ASP($) OPM (%) Market shares(%) Expected OP($) MLCC/Inductor $1.5 13% 65% $.9 HDI $6. -2% 25% $. FC-CSP $1.5 2% 6% $. Wifi-module $4. 2% 7% $.1 Camera module (dual) $29. 7% 75% $1.5 Wireless battery charger $5. 2% 55% $.1 Total $56. 4% 58% $2.5 Source: Credit Suisse estimates Figure 6: SEMCO's OP creation by components (SEC's high-end smartphone) Wireless battery charger 2% Camera module (dual) 59% MLCC/Inductor 35% FC-CSP 1% HDI -1% Wifi-module 2% Note: As of 217E. Figure 61: SEMCO's OP generation per unit of SEC's mid/low-end smartphone SEC: mid/low-end smartphone ASP($) OPM (%) Market shares(%) Expected OP($) MLCC/Inductor $7. 7% 65% $.3 HDI or SLP $4. -3% 15% $. FC-CSP $1. 1% 45% $. Wifi-module $3. 1% 4% $. Camera module (single) $8. 2% 45% $.1 Wireless battery charger $4. 1% 3% $. Total $27. 2% 4% $.4 Figure 62: SEMCO's OP generation per unit of China smartphone China smartphone ASP($) OPM (%) Market shares(%) Expected OP($) MLCC $6. 5% 35% $.1 Camera module (dual or single) $25. 5% 15% $.2 Total $31. 5% 25% $.3 Note: As of 217E. Source: Credit Suisse estimates Note: As of 217E. Source: Credit Suisse estimates Our sensitivity analysis suggests that SEMCO's OP could rise by ~W3 bn for every 1 mn units increase in shipments of SEC's high-end smartphones. We have not included potential ASP increase from SLP (Substrate Like PCB) yet for our analysis. Meanwhile, every 1 mn units increase in SEC's mid-/low-end smartphone shipments, SEMCO could generate additional W5 bn of OP. For SEC's mid-/low-end smartphones, we only consider Galaxy A or J series shipments. For China, we estimate every 1 mn units increase in China smartphone shipments could lead to W3 bn of OP for the company. In the China Samsung Electro-Mechanics (915.KS / 915 KS) 26

27 segment, we only include Xiaomi/Vivo/OPPO's smartphone shipments, which are currently SEMCO's clients. Figure 63: Sensitivity analysis of SEMCO's OP per SEC's high-end smartphone -1mn -5mn Base +5mn +1mn SEC's high-end smartphone(mn) SEMCO's OP creation per unit(us$) $2.5 $2.5 $2.5 $2.5 $2.5 USD/KRW SEMCO's OP generation(wbn) Note: As of 217E. Source: Credit Suisse estimates Figure 64: SEMCO's OP sensitivity per SEC's mid/low-end smartphone Note: As of 217E. Source: Credit Suisse estimates -1mn -5mn Base +5mn +1mn SEC's mid/low-end smartphone(mn, A/J series only) SEMCO's OP creation per unit(us$) $.4 $.4 $.4 $.4 $.4 USD/KRW SEMCO's OP generation(wbn) Figure 65: SEMCO's OP sensitivity per China smartphone Note: As of 217E. Source: Credit Suisse estimates -1mn -5mn Base +5mn +1mn China smartphone(mn, Xiaomi/vivo/OPPO only) SEMCO's OP creation per unit(us$) $.3 $.3 $.3 $.3 $.3 USD/KRW SEMCO's OP generation(wbn) Samsung Electro-Mechanics (915.KS / 915 KS) 27

28 Valuation Assuming coverage with OUTPERFORM and TP of W12, (2.2x P/B to 217E BVPS) Implied P/E is calculated by P/B divided by ROE on a 12-month forward basis We are assuming coverage of SEMCO with an OUTPERFORM rating and a TP of W12,. Despite the recent share price rally, we continue to remain bullish on the stock as the company's earnings recovery is still at an early stage, in our view. Consensus upward earnings estimates revisions cycle will likely continue, in particular for FY18E, given (1) rising dual-cam shipments driving operating leverage through utilisation recovery and blended ASP hikes; (2) MLCC ASPs will likely remain favourable amid limited global MLCC supply growth, while high-end embedded MLCC demand remains solid, and (3) lowered cost structure at substrates amid mix improvement on new product cycle (i.e., SLP). How should we interpret SEMCO's high P/E multiple? Historically, one of the core debates on SEMCO is how to interpret its demanding P/E multiple. SEMCO's P/E has been trading higher than its peers even though its P/B has been trading at a similar range. Based on our implied P/E analysis, more rapid ROE contraction than that of P/B has been driving the exaggeration of its P/E multiple. Particularly, SEMCO's high capex burden during the course of product diversification in the past seems to have led to enlarged total assets, which also worsened its ROE profile amid unexciting earnings growth due to its lowered asset turnover (i.e., LED, camera modules, power/tuner, HDD motors, passive components, etc) Figure 66: P/E multiple has been exaggerated due to more rapid ROE contraction vs P/B Figure 67: that phenomenon was worsened when book value growth outpaced earnings growth % % % 1% 8% 6% 4% 2% % 35% 3% 25% 2% 15% 1% 5% % -5%.. -2% -1% SEMCO - 12m - ROE(%) SEMCO - 12m - Implied PER(x) SEMCO - 12m PBR(x, RHS) SEMCO - OP YoY(%) SEMCO - BVPS YoY (%, RHS) Source: Wisefn, Company data, Credit Suisse estimates Samsung Electro-Mechanics (915.KS / 915 KS) 28

29 Figure 68: Too wide variety of product portfolio has resulted in heavy capex in the past Figure 69: Asset turnover decrease led to ROE contraction historically Wbn 1,4 Wbn 9, 18% X 1.2 1,2 8, 16% 1.1 1, , 6, 5, 4, 3, 2, 1, 14% 12% 1% 8% 6% 4% 2% Total assets (RHS) CAPEX % ROE(%) Asset turnover(x, RHS).4 Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research P/E exaggeration likely to diminish on rapid earnings upgrade SEMCO's ROE to recover to 4%/8% in FY17E/18E (vs % in FY16) We anticipate SEMCO's snapback ROE recovery into FY18E to drive a further share price rally, while 12-month forward-based implied P/E would continue to contract below 2x P/E on rapid earnings upward revisions on FY18E estimates. In addition to sharp earnings growth, SEMCO's efforts on restructuring on under-utilised assets in the past two years have limited total assets growth, which is also expected to boost rapid ROE recovery with a higher asset turnover (i.e., Power/Tuner/ESL/HDD motors spin-off or discontinuation in 215). Figure 7: Share price to have hit cycle peaks when implied 12-month forward P/E falls below 2x on rapid earnings upgrades on following years X Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 W 18, 16, 14, 12, 1, 8, 6, 4, 2, SEMCO - 12m - Implied PER(x) SEMCO - share px(rhs) Note = We calculated implied P/E through P/B divided by ROE. Source: Wisefn, company data, Credit Suisse estimates Samsung Electro-Mechanics (915.KS / 915 KS) 29

30 Figure 71: Earnings upgrades will continue, particularly for FY18 OP estimates Wbn W 12, 11, 1, 9, 8, 7, 6, 5, 2 4, Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 SEMCO OP SEMCO - share px (RHS) Source: Bloomberg consensus estimates, Credit Suisse research Figure 72: Rising asset turnover to improve ROE Figure 73: More room for the ongoing share price rally, given snapback ROE recovery into FY18E 18% 16% 14% 12% 1% 8% 6% X 14, 12, 1, 8, 6, 4, %.6 2, 2 2%.5 % E.4 ROE(%) Asset turnover(x, RHS) SEMCO share px SEMCO - 12mon fwd ROE(%, RHS) Source: Bloomberg consensus estimates, Credit Suisse research Source: Wisefn, Company data, Credit Suisse research Samsung Electro-Mechanics (915.KS / 915 KS) 3

31 Figure 74: SEMCO 12-month forward P/E W 3, 25, 2, 15, 1, 5, Share price 1x 18x 26x 34x Figure 75: SEMCO 12-month forward P/B W 18, 16, 14, 12, 1, 8, 6, 4, 2, Share price.8x 1.4x 2x 2.6x Figure 76: SEMCO historical valuations (29-16) Average Share price (W) High 113,5 16, 138, 112,5 87,4 62,5 74,6 58,7 1,9 Low 33,1 91,2 59,2 77,8 71,5 39,8 53,475 47,788 59,233 Average 68, ,942 96,548 98,459 79,111 51,859 63,91 52,565 79,332 P/E (x) High nm Low nm Average nm EPS (W) 3,589 7,148 4,53 5,68 4,256 6, P/B (x) High Low Average BVPS (W) 32,875 43,618 44,473 47,22 5,893 57,339 54,773 53,37 P/B to ROE (x) High , Low , Average , ROE (%) 11% 16% 1% 11% 8% 11% % % 8% Samsung Electro-Mechanics (915.KS / 915 KS) 31

32 Figure 77: Valuation comparison by major industry Mkt cap TP Price Up/ Note: Priced as of 14 June 217. NC = Not covered. Source: Bloomberg consensus estimates for Not Covered companies, company data, Credit Suisse estimates for covered companies ROE(%) PBR(X) PER(X) Company Ticker Rating CCY (US$mn) (local ccy) (local ccy) Down(%) E 218E E 218E E 218E Global camera modules (avg) 3% 16% 18% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% LG Innotek 117.KS OUTPERFORM KRW 3, , 154, 7% % 12% 11% Sunny Optical 2382.HK OUTPERFORM HKD 9, % 29% 38% 38% Lite-On 231.TW NEUTRAL TWD 3, % 12% 14% 14% O-Film 2456.SZ NEUTRAL CNY 6, % 1% 15% 18% Sharp 6753.T UNDERPERFORM JPY 17, % -23% 16% 16% Sony 6758.T OUTPERFORM JPY 46,763 4,7 4,6 16% 3% 12% 11% Q Tech 1478.HK NC HKD 851 n/a 6 n/a 14% 21% 23% Primax 4915.TW NC TWD 883 n/a 6 n/a n/a n/a n/a MCnex 9752.KQ NC KRW 179 n/a 22,25 n/a -32% 22% 26% Partron 917.KQ NC KRW 58 n/a 1,5 n/a 7% 1% 13% Cowell E 1415.HK NC HKD 256 n/a 2 n/a 1% 14% 15% Global passive components (avg) 1% 1% 1% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Murata 6981.T OUTPERFORM JPY 3,68 18,2 15,495 17% 13% 14% 14% Taiyo Yuden 6976.T NEUTRAL JPY 1,75 1, 1,632-39% 4% 5% 6% TDK 6762.T NEUTRAL JPY 8,54 8,5 7,42 15% 1% 1% 1% Yageo 2327.TW NC TWD 1,649 n/a 99 n/a 16% 16% 14% 2.3 n/a n/a 13.7 n/a n/a Walsin Tech 2492.TW NC TWD 872 n/a 51 n/a 15% 13% n/a 2. n/a n/a n/a Global PCB/PKG (avg) -6% 8% 11% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Kinsus 3189.TW NEUTRAL TWD 1, % 8% 7% 8% Unimicron 337.TW NEUTRAL TWD % -1% 1% 3% Ibiden 462.T UNDERPERFORM JPY 2,54 1,34 1,99-33% -21% 3% 3% Kyocera 6971.T NEUTRAL JPY 21,748 6,4 6,484-1% 4% 4% 5% Shinko 6967.T NEUTRAL JPY 1, % 2% 6% 7% AT&S ATSV.VI NC EUR 412 n/a 9 n/a -4% -3% 6%.7 n/a n/a n/a 13.1 n/a BH 946.KQ NC KRW 46 n/a 29,5 n/a -23% 3% 34% n/a Interflex 5137.KQ NC KRW 697 n/a 37, n/a -28% 14% 25% n/a Korea Circuit 781.KS NC KRW 331 n/a 15,6 n/a -2% 12% 13% n/a Daeduk GDS 413.KS NC KRW 329 n/a 17,9 n/a 2% 8% 9% n/a Overall (avg) 2% 11% 13% SEMCO 915.KS OUTPERFORM KRW 5,681 12, 85,1 41% 1% 4% 8% Samsung Electro-Mechanics (915.KS / 915 KS) 32

33 Investment risks We believe the key risks to our positive investment thesis are as follows: Dual-cam adoption delay at SEC's smartphones: As SEC's start of dual-cam adoption in its flagship smartphones would drive the blended ASP rise of camera modules along with utilisation recovery, any delay would limit OPM expansion potential. Our base case is that SEC will begin adoption of dual-cam in its upcoming Galaxy Note 8 smartphone from 2H17. Also, the Galaxy S9 in 1H18E is likely to have dual-cam, mainly supplied by SEMCO. Any irrational MLCC capacity expansion among global peers: If an aggressive MLCC capacity expansion takes place among global peers, particularly tier 1 players such as Murata, it could weigh on MLCC ASP hikes, which would limit SEMCO's passive components profitability enhancement potential. However, our base case assumes that MLCC pricing will remain favourable throughout 217 or even in 218, given supply discipline amid solid demand on high-end MLCCs, particularly for smartphones. AAPL could trigger further supply tightness in 2H17 for its upcoming iphone 8 components procurement with higher-specs. Mis-execution in restructuring at ACI (substrates/packaging): HDI is still a big burden on SEMCO by having generated significant operating losses. Any misexecution of cost cutting at HDI would pressure margin recovery despite growth potential from RF-PCB or SLP. For BGA, a faster-than-expected FO-WLP (Fan Out Wafer Level Package) or PLP (Panel Level Package) penetration at mobile A/P could pressure further top-line growth opportunities. Initial yield penalty at new product cycles: SEMCO's new business such as PLP or SLP will likely begin generating revenues from 2H17E. Worse-than-expected yield rates at the initial stage without scale effect could result in more-than-expected operating profit losses. For FO-PLP, we try to remain conservative in OP forecasts with estimates of W2 bn/w33 bn losses in FY17E/18E, considering initial yield penalties, inferior product-mix (i.e., PMIC, low-end memory, etc) and depreciation costs. SEMCO completed W263 bn of capex for PLP by end-216 and ~W11 bn of relevant equipment depreciation would start being recognised from 2H17E upon the commencement of revenue generation. ASP pressures from SEC: One of the key risks on SEMCO has been its higher earnings exposure to Samsung Electronics as a single client. This has led to aggressive ASP pressure, especially when SEC's product cycle was weak during the course of inventory correction. We also admit that SEMCO's earnings are highly dependent on the captive client; however, improving client mix through China is diluting the negative impact. SEMCO aims to reduce its sales exposure to SEC around 5% by end-217. Samsung Electro-Mechanics (915.KS / 915 KS) 33

34 Appendix Product details DM (Digital Modules) Camera modules: Camera module is built into mobile devices or electronic equipment like smartphones and tablet PCs to allow taking clear pictures or shooting clear films by using the self-focusing function, the image stabilisation function, etc. WLAN module: Wireless Lan module is a component that divides the high frequency signals received to the antenna of a mobile phone (LTE) into the transmission and reception signals for each communication band. Wireless charging: Wireless charging is a charging module allowing charging small electronic devices like smartphones wirelessly. Place an electronic device on the charging pad without the connection to a wired charging adapter or a power cable. LCR (Linkage of Magnetic Flux Coil Capacitor, Resistor) MLCC (Multi-Layer Ceramic Capacitor): MLCC is used in various IT devices such as handsets, PCs, TVs and even automobiles due to the increases in electronic components and functions. Because electrical signals contain various noise components such as EMI or equipment generated, these noises can cause problems like crosstalk, false-triggering, or incorrect logic levels. MLCC s basic functions are to: (1) reduce the high-frequency noise off the supply voltage to ICs or transistors (electron ripple elimination); (2) decouple one part of an electric circuit from another to reduce the effect on other parts of the circuit; (3) to smooth the voltage when AC signals are changed to DC signals before being sent to other circuits; and (4) store electros for high speed use. Chip inductor: Chip inductor is a key component of digital devices such as smartphones. It stably maintains the supply voltage of a chip or a sensor. Chip resistor: Chip resistor controls direct current or alternating current. With the characteristics, this component reduces the voltage in an electronic circuit or maintains the current. Figure 78: SEMCO Digital Modules major products Figure 79: SEMCO LCR major products Source: Company data Source: Company data Samsung Electro-Mechanics (915.KS / 915 KS) 34

35 Figure 8: SEMCO auto-electric components Figure 81: MLCCs usage in automotive Source: Company Note: MLCC inside a car stores electric charges temporarily, releases them when necessary (storage of charge) or removes the AC noises to stabilise the operation of IC (decoupling). Source: Company ACI (Advanced Circuit Interconnection) HDI (High Density Interconnection): HDI sends electrical signals between the electronic parts of smartphones, tablet PCs, laptop computers, digital cameras, etc. Package substrate: Package substrate connects semiconductor chips and substrates through wire bonding and solder ball bump. It sends electrical signals. RF-PCB (Rigid Flexible Printed Circuit Board): Rigid-Flex is a board composed of rigid and flexible substrates. Due to the bend of the flexible part, it is possible to connect a 3D circuit. With the various types of 3D wiring, board compactness and lightness are available. Figure 82: SEMCO ACI major products Figure 83: RF-PCB reduces the substrate size to allow smartphone battery size to increase and bezel size to reduce Source: Company Source: Company Samsung Electro-Mechanics (915.KS / 915 KS) 35