23 January 2009

NOK: Financial Analysis through December 2008

Nokia Corp. (NYSE: NOK) has announced its results for the fourth quarter of 2008 [pdf]. This post provides the GCFR analysis of the financial statements.

Headquartered in Espoo, Finland, Nokia sells mobile phones and network infrastructure. Nokia's portfolio of hand-held devices ranges from modest 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 can change quickly and dramatically.

Nokia's share of the cellular market is a little under 40 percent, far surpassing rivals Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570) and Sony Ericsson. However, Nokia's market share in North America is more limited, according to Fortune Magazine.

At the high end, Nokia also faces competition from Apple's (NASDAQ: AAPL) iPhone and Research in Motion's (NASDAQ: RIMM) Blackberry. Nokia responded to Apple by establishing its own online music service.

To better compete in the network infrastructure market, Nokia and Siemens (NYSE: SI) formed a 50/50 partnership in April 2007. The new company was named, with little imagination, NokiaSiemens Networks. NSN has annual sales of €13.4 billion, and its results are fully consolidated into Nokia's financial statements. This presents a 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, the GCFR Overall gauge of Nokia registered 49 of the 100 possible points -- down just two points. The third-quarter evaluation was explained fully in this analysis report.

The Cash Management, Growth, and Profitability scores were all down, but the Value gauge almost made up the slack. The Value score was lifted, seesaw fashion, by a 24 percent drop in the price of Nokia ADRs during the third quarter. The contrarian Value gauge, which is the largest contributor to the Overall score, tends to move in the opposite direction of the share price.

Nokia ADRs fell another 16 percent in price during the fourth quarter of 2008.

Back on 14 November 2008, Nokia reported that the global economic slowdown "has resulted in a sharp pull back in global consumer spending" and that the market for mobile devices has been impacted by this weakness. Nokia also observed that the "limited availability of credit" was affecting some of its customers.

Less than three weeks later, on 4 December 2008, Nokia announced that "The mobile device market slowdown has continued more rapidly than previously expected." The company lowered its estimates for the total number of mobile devices to be bought and sold, and it withdrew previous statements about maintaining market share.

Now, with the data from the December 2008 quarter, and subject to the comparability limitations identified above, our gauges display the following scores:
  • Overall: 38 of 100 (down from 49)

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.


Assuming modest volume growth and lower average prices, we expected Revenue would be down 4.5 percent from the year-earlier quarter, and it actually decreased by 19.4 percent. As a result, our estimate was too high by 18.5 percent. Revenue in 2008 was 1 percent below that in 2007.

We were also too optimistic about the Gross Margin. We thought the margin would drop from 36 to 34 percent of Revenue. In actuality, the margin fell to 32 percent, which translates into a Cost of Goods Sold (CGS) of 68 percent of Revenue.

We expected that Research and Development (R&D) expenses and Sales, General, and Administrative (SG&A) expenses would each be about 10.5 percent of Revenue. R&D was actually 13.7 percent, and SG&A was 12.9 percent, in the fourth quarter.

"Other" operating expenses were more than double our (rather arbitrary) estimate of a €100 million charge.

Lower Revenue and much greater-than-expected expected expenses resulted in Operating Income falling short of the forecast value by 73 percent. Operating Income was 80 percent less than Operating Income in the fourth quarter of 2007.

Interest ("Financial income and expenses") was a small net expense, whereas we expected a small gain.

The Income Tax Rate was (oddly) minus 16 percent, and served as source of income. The company attributed this to "a favorable high tech qualification assessment in China."

Net Income still fell short of our prediction by 59 percent. It was 69 percent below earnings in the December 2007 quarter.

Cash ManagementDecember
3 mos.
12 mos.
Current Ratio1.21.11.5
LTD/Equity 6.1%1.3%1.4%
Debt/CFO 1.4 yrs0.7 yrs0.2 yrs
Inventory/CGS 29.6 days32.2 days24.0 days
Finished Goods/Inventory N/AN/AN/A
Days of Sales Outstanding (DSO)74.3 days69.7 days61.1 days
Working Capital/Market Capitalization 6.6%4.3%6.9%
Cash Conversion Cycle Time 35.9 days34.8 days28.8 days
Gauge Score (0 to 25)

The two debt-related measures are up substantially, but aren't anywhere near worrisome levels. The expanded Inventory relative to last year's level is confirmation of the soft sales environment. 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

3 mos.
12 mos.
Revenue growth-0.7%14.3%24.2%
Revenue/Assets 131%145%170%
CFO growth -59%-9%76%
Net Income growth -42%-18%55%
Gauge Score (0 to 25)0
Growth rates are trailing four quarters compared to four previous quarters.

There's no good news on the Growth front, with CFO and Net Income contracting significantly.

3 mos.
12 mos.
Operating Expenses/Revenue 90.2%87.0%84.4%
ROIC 32.8%47.5%152%
FCF/Equity 15.9%40.6%53.6%
Accrual Ratio +9.3%+2.6%+0.1%
Gauge Score (0 to 25)7

Operating Expenses as a percentage Revenue has moved sharply higher. While ROIC has dropped, it is still impressive. FCF/Equity has become far more pedestrian. The rising Accrual Ratio is a significant area, as it indicates that earnings quality has decreased.

3 mos.
12 mos.
P/E 14.613.320.7
P/E to S&P 500 average P/E 108%74%116%
Enterprise Value/Cash Flow 17.410.717.6
Gauge Score (0 to 25)16

The price of Nokia ADRs dropped 54 percent, from $38.39 to $15.60, in 2008, which would ordinarily lift the contrarian Value gauge. However, the decline in earnings and cash flow was more dominant.

Nokia's valuation ratios can be compared with other companies in the Communications Equipment industry.

3 mos.
12 mos.
Gauge Score (0 to 100)38

Nokia CEO Olli-Pekka Kallasvuo stated:

"In recent weeks, the macroeconomic environment has deteriorated rapidly, with even weaker consumer confidence, unprecedented currency volatility and credit tightness continuing to impact the mobile communications industry. We are taking action to reduce overall costs and to preserve our strong capital structure."

It is not surprising, therefore, to see declines in all our gauges for Nokia, except the unchanged Cash Management measure. The Overall gauge, now at 38 points, no longer presents an optimistic assessment of the company's performance and value. Up until the fourth quarter, we had suspected that Nokia shares were being discounted more than warranted, but we no longer hold this view.

Cash Flow from Operations in the fourth quarter of 2008 was negative, which hadn't happened in the 11 years (44 quarters) for which we have data. However, Cash Flow would have been substantially positive if not for a €1.7 billion payment to Qualcomm (NASDAQ: QCOM) as part of a licensing agreement.

The global market for mobilie phones was down 9 percent, but Nokia's share was cut by 15 percent. Nokia’s market share in the recent quarter was 37 percent, compared with 40 percent in the fourth quarter 2007.

The dividend for the year was cut 24.5 percent.

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