22 March 2009

NOK: Look Ahead to March 2009 Quarterly Results

The GCFR Overall gauge of Nokia dropped from 49 to 38, of 100 possible points, in the fourth quarter of 2008.  The evaluation was explained fully in this analysis report.  

The recent tweaks to our gauges bumped up the Overall score by four points to 42, but this change didn't alter the decline from the previous quarter.

The market for cellular/mobile telephones contracted more than Nokia had first anticipated in the last three months of 2008.  The company's Revenue dropped 19 percent from the equivalent period in 2007.  Operating Income fell by 80 percent, and Net Income was down 69 percent.  A "favorable high tech qualification assessment in China" and certain other tax benefits resulted in a substantial (€200 million?) income tax credit and prevented fourth-quarter earnings from being even worse.  (We're curious as to why the Chinese matter affecting taxes is mentioned in Nokia's fourth quarter report, but not in the 20-F annual report.)

The Cash Management and Growth gauges were especially weak after the fourth quarter, with Growth sinking to zero of the 25 possible points.  The contrarian Value gauge, which tends to move in the opposite direction of the share price, remained respectable at 16 points. 

The price of Nokia ADRs fell 59 percent in 2008.

To look ahead, we've modeled Nokia's Income Statement for the first quarter of 2009.  The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that Nokia will announce on 16 April 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

Headquartered in Espoo, Finland, Nokia sells mobile phones and network infrastructure.  Nokia shipped 468 million mobile devices in 2008, which was, according to company estimates, approximately 39 percent of the global market.  Nokia claims to have been the worldwide market share leader since 1998.  However, Nokia's share of the North American market is more limited, according to Fortune Magazine

Nokia's rivals include Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570) and Sony Ericsson.  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.

Nokia's portfolio of hand-held devices ranges from modest phones with tight profit margins to units that are stylish, feature-laden, and expensive.  The market for these devices, which until recently had been growing at a rapid pace, is highly competitive, and product development cycles are short.  This environment can produce sudden changes in the relative fortunes of the various manufacturers (cf., Motorola).

In February 2009, Nokia decided to use chips made by Qualcomm (NASDAQ: QCOM) in its 3G phones.  The two companies resolved a long-running patent dispute last summer that resulted in Nokia paying Qualcomm €1.7 billion.

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 had sales of €15.3 billion in 2008 (about 30 percent of Nokia's total annual revenue), and NSN's 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.

Nokia said in January it would cut costs because of the weak economy.  Details emerged in February when "voluntary measures aimed at reducing personnel-related costs" were announced.  Just one month later, Nokia reported that it would scale back its staff by approximately 1700 people "to match the pruned portfolio and global consumer demand; address the marketing and other activities that will no longer be integral following the Symbian acquisition; streamline the Devices R&D organization; and increase efficiency in certain global support functions."
Further cost-cutting actions might be necessary at Nokia because the mobile phone market has become much more mature.

Nokia, when it reported results for the fourth quarter of 2008, also described its first-quarter 2009 outlook for the industry, in general, and for the company, in particular.  The outlook did not include specific Revenue or Earnings guidance, but the information nevertheless helps us understand management's expectations for the operating environment and how well the company's different businesses will perform in it.

Although Nokia sells services and non-mobile devices, we use data characterizing the mobile phone market to estimate the company's overall Revenue. 

The company indicated that it expects the total number of mobile phones sold worldwide to decline by 10 percent in 2009, with the decline steeper in the earlier part of the year.  Nokia is evidently anticipating that business conditions will stabilize in mid-year.  This forecast might prove optimistic, but only time will tell.  If the number of units sold in the first quarter of 2009 falls by, say, 12 percent, and the average price per unit declines by 14 percent, which was the case in the fourth quarter of 2008, Nokia's first quarter Revenue will be 0.88 * 0.86 = 76 percent of the €12.7 billion in Revenue during the March 2008 quarter.

This results in a rough €9.6 billion estimate for Revenue in the first quarter.  The calculation doesn't include the effects of currency exchange rate fluctuations, which might be substantial.

Nokia's Gross Margin was 34.3 percent in 2008, but it was only 32 percent in the fourth quarter.  We expect it to fall further, maybe as low as 30 percent, in the first quarter because Revenue will be much less.  Therefore, our estimate for Costs of Goods Sold in the quarter is (1 - 0.3) * €9.6 billion = €6.7 billion.

Research and Development and Sales, General and Administrative expenses are normally between 10 to 12 percent of Revenue.  Nokia has indicated its intent to cut costs, but we doubt the cost reduction will match the decline in Revenue.  For the first quarter of 2009, we will assume that each expense will be 10 percent less than in the March 2008 quarter.  If true, these expenses would each be about 12.8 percent of estimated Revenue.  

It's hard to even guess at what other operating items (e.g., restructuring charges, workforce reduction expenses, asset impairment) Nokia might report in the first quarter.  We will simply use 2008's average special charge per quarter, which was almost €200 million.

With these figures, our estimate for Operating Income is €247 million.  This value is 84 percent less than Operating Income in the first quarter of 2008.

Miscellaneous non-operating items (e.g., interest) were historically, in the aggregate, a minor source of income.  In late 2008, this category became a small net expense.  For the first quarter, we will assume the figures balance out.  If we assume an effective 26 percent tax rate, and €25 million for Minority Interests (the 2008 average), our prediction for Net Income is €207 million (€0.06/share).  This estimate is down 83 percent from the year-earlier quarter.

Please note that the table format below, which we use for all analyses, can and often does differ in material respects from company-used formats.  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.


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