Nokia, headquartered in Espoo, sells mobile phones and network infrastructure. Nokia's portfolio of hand-held devices ranges from low-end phones with tight profit margins to units that are stylish, feature-laden, and expensive. In this competitive market, with short product development cycles, the relative strength of each manufacturer changes quickly and dramatically. Nokia's share of the cellular market is presently close to 40 percent, far surpassing rivals Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570) and Sony Ericsson. At the high end, Nokia also faces Apple's (NASDAQ: AAPL) iPhone and Research in Motion's (NASDAQ: RIMM) Blackberry. Nokia responded to Apple by establishing its own online music service.
A few weeks before the end of the third quarter, Nokia announced that its share of the mobile device market would be lower and not, as previously stated, remain about the same. Nokia chose to not match the price cuts some competitors implemented in response to the slowing economy.
To better compete in the network infrastructure market, Nokia and Siemens (NYSE: SI) formed a 50/50 partnership. The new company, established in April 2007, was named, not-so-imaginatively, NokiaSiemens Networks. NSN has annual sales of €13.4 billion, and its results are fully consolidated into Nokia's financial statements. This presents an comparability challenge because Nokia's financial statements before April 2007 don't include the businesses the German powerhouse contributed to the partnership.
Three months ago, our Overall gauge of Nokia reached 54 of the 100 possible points, which was its highest score since 2003. Readers are referred to this analysis of Nokia's second-quarter results for the details. The increase in the composite score from 37 points in March was the product of the Profitability gauge rising from 15 to 19 points (of 25 possible), and the Value gauge zooming from 5 to 14 of 25 points. The upward movement in the Value gauge reflected the significant drop in the price of Nokia ADRs during the second quarter.
Now, with the data from the September 2008 quarter, and subject to the comparability limitations identified above, our gauges display the following scores:
- Cash Management: 5 of 25 (down from 8 in the second quarter)
- Growth: 1 of 25 (down from 6)
- Profitability: 12 of 25 (down from 19)
- Value: 20 of 25 (up from 14)
- Overall: 51 of 100 (down from 54)
Before we examine the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously announced expectations.
Nokia's financial statements are prepared in accordance with International Financial Reporting Standards (IFRS), rather than U.S. Generally Accepted Accounting Principles (GAAP). The Euro(€) is the currency used in these statements. Also, Nokia isn't required to file 10-Q and 10-K reports with the SEC.
Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats and terminology. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| (€M) | | September 2008 (actual) | September 2008 (predicted) | September 2007 (actual) |
| Revenue | | 12,237 | 13,400 | 12,898 |
| Op expenses | | | | |
| | CGS | (7,878) | (9,112) | (8,472) |
| | R&D | (1,466) | (1,407) | (1,386) |
| | SG&A | (1,361) | (1,407) | (1,277) |
| | Other | (63) | (250) | 99 |
| Operating Income | | 1,469 | 1,224 | 1,862 |
| Other income | | | | |
| | Investments | 30 | 10 | (2) |
| | Interest, etc. | (57) | 50 | 67 |
| Pretax income | | 1,442 | 1,284 | 1,927 |
| Income tax | | (355) | (340) | (364) |
| Net Income | | 1,087 | 944 | 1,563 |
| | | €0.29/sh | €0.25/sh | €0.40/sh |
| Shares outstanding | | 3,736 | 3,750 | 3,919 |
We expected Revenue would be a modest 4 percent greater than in the strong year-earlier quarter, and it actually decreased by 5 percent. As a results, our estimate was too high by 9.5 percent -- a big miss. Changes in currency conversion rates explains most of the error. Revenue growth on a year-over-year (i.e., trailing four quarters) basis was 14 percent.
While we were too optimistic about Revenue, it turned out that we were too pessimistic about the Gross Margin. Because of tough economic conditions, we thought the margin would drop to 32 percent of Revenue. In actuality, Nokia was able to maintain a margin of 35.6 percent, which translates into a Cost of Goods Sold (CGS) of 64.4 percent of Revenue.
Research and Development (R&D) expenses were 4 percent more than we expected, and they were also higher than we anticipated when measured as a percentage of Revenue (12 vs. 10.5 percent). On the other hand, Sales, General, and Administrative (SG&A) expenses were 3 percent below our estimate, but a higher Revenue percentage (11.1 vs. 10.5 percent).
"Other" income and expenses had resulted in a net charge of about €250 million in both of the first two quarters of the year, and we expected something similar in the third quarter. Instead, the net charge was a far less onerous €63 million.
The much better-than-expected Gross Margin, and the much less-than-expected Other charges, resulted in Operating Income, exceeding the forecast value by 20 percent. Operating Income was still 21 percent less than in the year-earlier quarter.
It's noteworthy that Interest ("Financial income and expenses") was a negative figure, representing a net expense. This item had been positive every quarter of the current decade.
The Income Tax Rate was only 24.6 percent, instead of the predicted 26.5 percent. Net Income surpassed our prediction by 15 percent. Nevertheless, it was 30 percent below earnings in the September 2007 quarter.
Cash Management. This gauge decreased from 8 points in June to 5 points now.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Current Ratio | 1.1 | 1.4 | 1.5 |
| LTD/Equity | 1.3% | 1.4% | 1.8% |
| Debt/CFO | 0.7 yrs | 0.2 yrs | 0.1 yrs |
| Inventory/CGS | 32.2 days | 28.0 days | 29.8 days |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 69.7 days | 66.0 days | 60.3 days |
| Working Capital/Market Capitalization | 4.3% | 7.8% | 5.8% |
| Cash Conversion Cycle Time | 34.8 days | 33.9 days | 28.9 days |
Note the big increase in Debt/CFO. Long-term debt was down, as can be seen above, but the Balance Sheet shows that short-term borrowing rose from €500 million to €4 billion. Nokia's management might have filled their war chest with cash to protect the company against problems in the credit markets. The rising Inventory level is indicative of the soft sales environment, and it suggest that sales might have been even slower than management expected. We remark every quarter that it's too bad Nokia doesn't identify the proportion of Inventory made up of Finished Goods. The increase in Days of Sales Outstanding, which is reflected in the rising the Cash Conversion Cycle Time, suggests poorer cash efficiency
Growth. This gauge decreased from 6 points in June to 1 points now.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Revenue growth | 14.3% | 23.0% | 18.3% |
| Revenue/Assets | 145% | 167% | 170% |
| CFO growth | -9.0% | 19.4% | 75.8% |
| Net Income growth | -21.0% | -3.4% | 61.8% |
There's no good news on the Growth front, which is hardly a surprise. The drop in Net Income was magnified by last year's accounting for the formation of the Nokia Siemens Networks partnership, which led to a huge, tax-free gain.
Profitability. This gauge decreased from 19 points in June to 12 points now.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Operating Expenses/Revenue | 86.1% | 85.9% | 88.9% |
| ROIC | 51.3% | 108% | 92% |
| FCF/Equity | 40.6% | 50.4% | 49.7% |
| Accrual Ratio | +2.6% | -3.6% | +2.5% |
We're very encouraged to see Operating Expenses under control. While ROIC has dropped, it is still, to say the least, impressive, as is FCF/Equity. The rising Accrual Ratio is the one difficult area, as it suggests that earnings quality has decreased.
Value. The gauge, which takes a contrary view of share price changes, had risen to 14 points by the end of June. From the beginning of July to the end of September, the price of Nokia ADRs dropped from $24.50 to $18.65, which would tend to lift the Value gauge. Early October's market crash knocked the price as low as $16, adding still more lift. Using the 30 September price, per GCFR standard practice, the Value gauge score is a robust 20 points.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| P/E | 13.3 | 16.2 | 22.4 |
| P/E to S&P 500 average P/E | 79% | 88% | 131% |
| Price/Revenue | 1.3 | 1.7 | 3.2 |
| Enterprise Value/Cash Flow | 10.7 | 12.5 | 20.6 |
The third quarter trimmed all of our gauges for Nokia, except the Value measure that soared as the stock market declined. The Overall gauge, now at 51 points, presents a mildly optimistic assessment of the company's performance and value. Nokia certainly has some significant challenges, but investors appear to have punished the shares more severely than warranted.
Sales and, especially Net Income, were down in the quarter. We can attribute this to the slowing global economy, changes in currency conversion rates, and increased competition. However, Nokia was able to hold onto a large fraction of its mobile device market share -- 38 percent, down from 39 percent in the year-earlier quarter -- while keeping most costs under control. Nokia's sales aren't going to be growing as fast as they once did, yet Nokia can still be highly profitable.
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