How Samsung weathered the Galaxy Note 7 recall

Despite debacle, South Korean tech giant forecasts its highest profit in more than three years

Samsung Electronics Co. delivered a reminder of the company’s central role in the global technology supply chain with a strong earnings forecast on Friday.

Even with the early-October recall of its premium Galaxy Note 7 smartphone that cost it at least $5 billion, Samsung projected fourth-quarter earnings that would be the highest in more than three years. The reason: competitors’ growing demand for Samsung components.

While Samsung’s smartphone results took a hit, the company thrived on sales to the likes of Apple Inc., Dell Inc., HP Inc. and Sony Corp., whose smartphones, laptops and televisions rely on parts manufactured by the South Korean technology giant.

Samsung’s ability to shake off the recall of 2.5 million Note 7 smartphones last year highlights how even when the conglomerate loses, it can still win. Its forecast Friday of 9.2 trillion Korean won ($7.76 billion) in fourth-quarter operating profit also illustrates a shift in the source of tech industry profits.

As recently as 2014, Samsung’s mobile phones were the cash cow. But with consumers no longer snapping up new phones every year, the company—which is the world’s biggest maker by shipments of both smartphones and memory chips—has shown there is plenty of profit to be made in the parts of devices not visible to most consumers.

Global smartphone shipments have slowed sharply, registering growth of less than 1% last year, according to a recent estimate by research firm IDC. Growth in 2015 topped 10%, and as recently as 2012 was 47%.

Even as smartphones were selling strong, Samsung continued to pour tens of billions of dollars into semiconductors and display panels to enable phones to run faster, hold more storage and offer crisper images. Recent advances have made its components more powerful than those of competitors—positioning Samsung as an essential parts supplier for many of its rivals.

This friend-and-foe dynamic means Samsung can profit, for instance, even when a consumer ditches a Galaxy phone for a competitor’s product.

“If Apple does well, Samsung benefits from that,” said Sanjeev Rana, a senior analyst at CLSA, a brokerage, in Seoul.

A rival Korean smartphone maker is proving more vulnerable to the industry’s slowdown in demand. LG Electronics Inc. said Friday that it expects to report its largest quarterly loss in seven years after shifting its accounting standard. Analysts say the fourth-quarter hit was most likely driven by the company’s mobile division, which is projected to have bigger losses than its record loss in the previous quarter. On Friday, LG estimated that it would lose 35.3 billion Korean won ($29.8 million) in 2016’s final quarter.

Samsung’s recall of overheating Galaxy Note 7 phones last year attracted global scrutiny and has hurt its brand image. But Mr. Rana of CLSA reckons even a more fortunate Note 7 wouldn’t have sold more than 15 million units globally—a fraction of the more than 300 million handsets that Samsung sells every year. In fact, Samsung’s latest flagship phone, the Galaxy S7, showed surprising resilience in the Note 7’s absence, enjoying brisk sales during the fourth quarter—nearly a year after it was first released.

Samsung is likely to book recall costs that will affect its bottom line for the fourth quarter. Nonetheless, C W Chung, a Seoul-based analyst at Nomura, said the projections for operating profit were “quite a surprising number” to the upside.

As its reliance on smartphones has diminished, Samsung has looked to build on its dominance in electronic components by expanding its capacity as a chip and display-panel manufacturer.

Last November, Samsung announced that it would invest more than $1 billion in its Austin, Texas, semiconductor factory to beef up its production of processor chips for smartphones and other devices. Samsung is also investing close to $10 billion to expand its production of organic light-emitting diode, or OLED, displays that are thinner than traditional liquid-crystal displays.

Despite the company’s woes with the Galaxy Note 7, investors pushed Samsung shares to record highs in the past week. On Friday, the stock rose 1.8%, giving Samsung a market capitalization of more than $240 billion—about one-third of Apple’s market value.