01 June 2009

NOK: Look Ahead to June 2009 Quarterly Results

The GCFR Overall gauge of Nokia (NYSE: NOK) was essentially unchanged at 42 of the 100 possible points after the first quarter of 2009, which ended on 31 March.  Our analysis report explained in some detail how the score was attained.

The first quarter was a tough one for Nokia and other cell-phone manufacturers.  Compared to the previous year, Nokia sold 19 percent fewer mobile devices, its average price per unit sold declined by 8.5 percent, and its market share slid from 39 to 37 percent.  Revenue fell by 27 percent, and the Gross Margin dropped from 36 percent of Revenue to 31.3 percent.  The company also recorded substantial restructuring and asset impairment charges, which caused a 96-percent plunge in Operating Income.

Net Income before Minority Interests was positive in the first quarter only because of a €16 million income tax benefit. And, Minority Interests contributed essentially all of the €0.03 per share of profit attributable to the equity holders of the parent company.

The big drop in the price of Nokia ADRs added just enough lift to our contrarian Value gauge to keep the Overall Gauge in balance.  The ADRs fell 70 percent from the close on 31 December 2007 of $38.39 to $11.67 on 31 March 2009.  The price has recently rebounded to about $15.

We have now modeled Nokia's Income Statement for the quarter that will end on 30 June 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce in mid July.  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 has been the leading global producer of mobile phones since 1998.  The company also sells the network infrastructure that supports these phones.  Nokia shipped 468 million mobile devices in 2008, which was, according to company estimates, about 39 percent of these devices sold worldwide.  Nokia's hand-held product line ranges from modest phones with tight profit margins to units that are stylish, feature-laden, and expensive.  The market for these devices is highly competitive, and product development cycles are short.

Rivals include Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570) and Sony Ericsson.  At the high end, Nokia's hand-held products compete with Apple's (NASDAQ: AAPL) iPhone and Research in Motion's (NASDAQ: RIMM) Blackberry.  The new Ovi service for selling handset software is Nokia's counterpoint to Apple's iPhone store.  There were some opening-day glitches, and it garnered some less-than-favorable reviews.  Ovi builds on the online music service Nokia established in late 2007.

Although a global powerhouse, Nokia's share of the North American market is more limited according to Fortune Magazine.   All Things Digital noted during an interview with Nokia's CEO that the company's inability to find a U.S. carrier to promote the new N97 high-end device is illustrative of Nokia's difficulties.

The fast-paced worldwide growth of mobile device sales abruptly reversed course in 2008, and sales were down sharply in the first quarter of 2009.  Reuters quoted a Gartner analyst predicting that demand for these devices would not pick up before the second half of 2010.

Nokia has reacted to the weak sales environment by implementing various cost-cutting measures, which include a 1700-person staff reduction.

In February 2009, Nokia decided to use chips made by Qualcomm (NASDAQ: QCOM) in its 3G phones.  When these two companies resolved a long-running patent dispute last summer, Nokia paid 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, when it reported results for the first quarter of 2009, also described its outlook for the industry and for the company.  The outlook does 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.

Revenue is going to be much less than the €13.15 billion of 2008's second quarter.  To come up with a rough estimate of how much less, we simply consider number of products sold and average sales price.  There are many other variables that affect Nokia's top-line, but information on these two items is available from the company and from press reports.

For example, Reuters reported that analysts, on average, expect "handset vendor phone sales in the April-June quarter to slump 14.5 percent."  For Nokia, we think it is reasonable to assume a less-severe 13 percent drop because infrastructure sales should be less volatile and because Nokia expects its market share to "increase sequentially."

In the first quarter, Nokia's average selling price for mobile devices was €65.  Although prices certainly remain under pressure, we're going to assume the same average price for the second quarter because inventory liquidation should be less and high-end smart phones should comprise a greater proportion of the product mix. Since Nokia's average selling price in the second quarter of 2008 was €74, we're assuming a year-to-year decline of 12 percent.

Therefore, our rough estimate for Nokia's second-quarter Revenue is (1 - 0.13) * (1 - 0.12) * €13.15 billion = €10.1 billion.

In the first quarter, Nokia's Gross Margin was about 32 percent if some one-time costs are excluded.  If we assume the same margin in the second quarter,  Costs of Goods Sold in the quarter will be about (1 - 0.32) * €10.1 billion = €6.8 billion.  The Gross Margin in the second quarter of 2008 was 33.6 percent.

We assume that Nokia will trim its Research and Development and Sales, General and Administrative expenses, but we doubt the cost reduction percentage will match the decline in Revenue.  For the second quarter of 2009, we will assume that each expense will be 10 percent less than in the June 2008 quarter.

It's hard to predict what other operating items (e.g., restructuring charges, workforce reduction expenses, asset impairment) Nokia might report in the second quarter.  Our €70 estimate is the average of the last 10 quarters, excluding the highest and lowest values.

With these figures, our estimate for Operating Income is €700 million.  This value is less than half the value in the same period of last year.

Non-operating items (e.g., interest) were historically minor for Nokia.  Given the first results of the first quarter, we will simply assume a net expense of €100 million. 

Nokia has recorded income tax benefits in the last two quarters, but we assume a more typical 26 percent tax rate will be applicable in the second quarter.  If we also assume  €25 million for Minority Interests (the 2008 average), our prediction for Net Income is €470 million (€0.13/share).  This estimate is down 57 percent from the year-earlier quarter.

Please note that the Income Statement presentation format 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.

Click here for a larger version of the spreadsheet.

Full disclosure: Long NOK at time of writing.

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