NOK: Financial Analysis through September 2007

We have analyzed Nokia's (NOK) financial results for the quarter that ended on 30 September 2007.

The formation last April of Nokia Siemens Networks, a 50/50 partnership with the German powerhouse, has made it difficult to analyze Nokia's finances. The results of the partnership, which would be considered a large-cap company if independent, are fully consolidated in Nokia's financial statements. Current results, which include the businesses contributed by Siemens, are, therefore, not directly comparable to the company's earlier figures.

We didn't feel we understood the effects of the partnership well enough to forecast the third-quarter results.

When assessing Nokia, readers are strongly cautioned to consider the comparability question. In addition, readers should be aware of some facts about Nokia's financial reporting that distinguish it from companies based in the U.S. First, the financial statements are prepared in accordance with International Accounting Standards (IAS), rather than U.S. Generally Accepted Accounting Principles (GAAP). Second, the Euro is the currency used in Nokia's financial statements. Third, Nokia isn't required to file 10-Q and 10-K reports with the SEC.

Nokia, headquartered in Espoo, Finland, is a global seller of cellular phones and the equipment for mobile phone networks. Nokia once held a commanding, and quite rewarding, position in the mobile phone market. Today, consumers have many more choices, and the phones sport stylish designs can outshine their technical capabilities in the battle for popularity. Nokia's fortunes suffered at the onset of this sea change, and market share was lost to Motorola's (MOT) Razr. Nokia subsequently adjusted, and now their share of the mobile phone market is increasing.

Challenges remain, however, including Apple's (AAPL) iPhone and an increasingly contentious patent battle with Qualcomm (QCOM ). Nokia will respond to the first threat by establishing their own online music service.

When we analyzed Nokia after the June quarter, the Overall score was a disappointing 28 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 14 points. Cash Management and Value were weakest at three points each.

Now, with the available data from the September 2007 quarter, and subject to the comparability limitations identified above, our gauges display the following scores:

• Cash Management: 4 of 25
• Growth: 14 of 25
• Profitability: 13 of 25
• Value: 0 of 25
  

• Overall: 25 of 100
  

Cash Management. This gauge increased from 3 points in June to 4 points now.

The measures that helped the gauge were:

• LTD/Equity = 1.8%; minuscule
• Current Ratio =1.5; not bad, but down from 1.8 in Sept 2006.
  

The measures that hurt the gauge were:

• Cash Conversion Cycle Time (CCCT) = 28.9 days, up from 22.9 days, for this measure of efficiency.
• Working Capital/Market Capitalization = 5.8 percent, down from 9.9 percent.
• Inventory/CGS = 29.8 days, compared to 27.0 and 27.4 days 3 and 12 months ago, respectively. (Nokia doesn't identify inventory composition; we'd like to know the proportion of finished goods.)
  
• Days of Sales Outstanding (DSO) = 60.3 days, significantly greater than the 48-day level one year earlier.
• Debt/CFO = 0.1 years; it's too low to drop. (Ed. Note: consider gauge adjustment).
  

Growth. This gauge held steady at the 14 points achieved in June. Some of the growth can be attributed solely to the new partnership.

The measures that helped the gauge were:

• CFO growth = 75.8 percent (!!!) (yr/yr), up from flat CFO growth.
• Net Income growth = 61.8 percent (yr/yr), up from 13.2 percent in a year.
• Revenue growth = 18.3 percent (yr/yr), good but down from 19.3 percent in a year.
  

Keep in mind that Net Income benefited from a change in the income tax rate from 26 to 13 percent.

The measures that hurt the gauge were:

• Revenue/Assets = 139 percent, down from 184 percent in a year; the increase in assets was greater than the increase in revenue.
  

Profitability. This gauge held steady at the 13 points achieved in June.

The measures that helped the gauge were:

• ROIC = 42 percent, although a skosh lower than last year's 44 percent
• FCF/Equity = 46 percent (!), up from 29 percent in a year
• Accrual Ratio = +1.8 percent, down from +4.0 percent in a year (good cash flow).
  

The measures that hurt the gauge were:

• Operating Expenses/Revenue = 88.9 percent, up from 86.5 percent in a year.
  

The increase in operating expenses was primarily the result of small increases in R&D and SG&A costs as a percentage of revenue.

Value. Nokia ADR's shot up an incredible 35 percent from $28.11 to $37.93 over the course of the quarter. The price surge came on top of good gains earlier in the year. It's not surprising that the Value gauge dropped to zero under these circumstances.

None of our measures could push the gauge into positive territory.

• Enterprise Value/Cash Flow = 20.6, up from 18.6 in Sept 2006
• P/E = 22.4, up from 19.4
• P/E to S&P 500 average P/E = 39 percent premium, compared to its five-year median of a 23-percent premium
  
• Price/Revenue ratio = 3.2, compared to its five-year median of 2.3.
  

The average P/E for the Communications Equipment industry is currently a much more expensive 33. The average Price/Revenue for the industry is currently 5.

Now at 25 out of 100 possible points, the Overall gauge dropped despite substantial increases in revenue, cash flow, and earnings. This is because the stock has already surged (in part, because of the weakening dollar), costs went up faster than revenues, and the earnings increase was driven as much by financial restructuring and tax changes than core operations. It will probably take a year or so for outside observers to really get a handle on the sustainability of Nokia's earnings. In the mean time, caveat emptor.