19 August 2010

NOK: Financial Gauge Analysis for the June 2010 Quarter

Nokia Corp. (NYSE: NOK) earned 0.06 per diluted share on an IFRS basis in 2010's second quarter, which ended on 30 June, down from €0.10 in the same quarter of 2009.

Second-quarter earnings fell from €0.15 to €0.11 per share on a non-IFRS basis, which excludes items such as restructuring charges and intangible asset amortization.
In our earlier review of Nokia's Income Statement, we compared the actual results to our revised "look-ahead" estimates.  Reported earnings were €0.01 less than the €0.07 per share we had forecast for the second quarter.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for Nokia and the associated financial gauge scores.  The metrics were calculated using data from Nokia's  current and historical financial statements.

Before getting into the details, we will take one step back to introduce the subject of today's analysis.

A Finnish company with a rich history, Nokia Corporation has been the leading global producer of mobile phones since 1998. Nokia also sells the network infrastructure that supports these phones. The company has three business segments: Devices and Services (D&S), Nokia Siemens Networks (NSN), and NAVTEQ. Despite a substantial head start, Nokia has been losing market share to upstarts such as Apple's (NASDAQ: AAPL) iPhone in the smartphone product category.

Additional background information about Nokia and the business environment in which it is currently operating can be found in the look-ahead.

In summary, Nokia's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit.

Cash Management30 Jun 201031 Mar 201030 Jun 20095-yr Avg
Current Ratio1.
LTD to Equity27.7%25.6%27.4%8.0%
Debt/CFO (years)
Inventory/CGS (days)26.326.731.726.7
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)71.373.481.162.2
Working Capital/Revenue18.6%17.6%12.0%18.4%
Cash Conversion Cycle Time (days)31.433.041.630.2
Gauge Score (0 to 25)1918510

Values for Nokia's Long-term Debt/Equity ratio have been much higher in the last year than they were in earlier periods.  Nokia's long-term debt started to surge in late 2008 after being relatively negligible for many years.  In less than a year, long-term debt got over €4.0 billion, and it has stayed over that level for the last five consecutive quarters.

Although the debt increase got our attention, the rise couldn't have been considered problematic given the ample amounts of Cash and Short-term Investments (€9.85 billion on 30 June 2010) listed on the company's Balance Sheet.  It's not obvious why the company chose to tap the debt market for funds, instead of reaching into its existing cash hoard.  Perhaps, it needed additional liquidity to deal with fluctuating currency exchange rates.

When total debt (long and short) is compared to Cash Flow from Operations, which is a prime source of funds for debt repayments, the situation has recently improved.  While long-term debt is still over €4.0 billion, total debt is only 1.3 times CFO in the last four quarters.  Total debt was almost 3 times CFO only 12 months earlier.

Another positive change has been the reduction in the company's Inventory from 31.7 days in June 2009 to 26.3 days in June 2010.

The number of Days of Sales Outstanding has dropped even more steeply, but it remains above the 5-year average for this cash efficiency metric.

Growth30 Jun 201031 Mar 201030 Jun 20095-yr Avg
Revenue Growth-6.3%-12.9%-19.0%3.9%
Operating Profit Growth-9.0%-6.2%5.4%-8.0%
CFO Growth110.1%44.6%-71.4%23.3%
Net Income Growth-86.9%-84.0%-66.4%6.5%
Gauge Score (0 to 25)55111
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in
Operating Profit after Taxes over the last 16 quarters.

Cash Flow from Operations is a very bright spot in the Growth table.  This important measure has more than doubled in the last four quarters.  We do have to note that the magnitude of the increase may say more about last year's weakness than current performance.

Although Revenue in the June 2010 quarter was slightly greater than in the same period of 2009, trailing-year Revenue growth remains negative.  However, the rate of the revenue decline has clearly decelerated.

The Revenue/Assets ratio seems to have stabilized at about 110 percent after having dropped substantially in the last year.

The decline in IFRS Net Income was steepened by a staggering €908 million intangible-asset impairment charge in the third quarter of 2009 (related to Nokia Siemens Networks).  Unusual tax matters in the last two quarters also negatively affected Net Income.

Profitability30 Jun 201031 Mar 201030 Jun 20095-yr Avg
Operating Expense/Revenue94.2%93.8%93.5%89.8%
Free Cash Flow/Invested Capital29.6%26.8%11.3%65.3%
Accrual Ratio-2.0%0.0%13.5%-0.5%
Gauge Score (0 to 25)1010813

The decline in Nokia's operating margin, as indicated by increased expenses relative to revenue, remains a significant drag on Profitability.

As was the case with the Growth metrics, Cash Flow is also the star of the Profitability category.  Free Cash Flow as a percentage of Invested Capital has recovered smartly in the last couple of quarters.  Better Cash Flow figures also helps the Accrual Ratio's (where lower is better) indication of earnings quality.

Declining ROIC, exacerbated by special charges, remains a concern.

Value30 Jun 201031 Mar 201030 Jun 20095-yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)6.213.426.716.3
Gauge Score (0 to 25)13997
Share Price ($)$8.15$15.54$14.58-

The plunge experienced by Nokia ADRs in the second quarter provided some support for the Value gauge because the price decline was more pronounced than changes in the company's fundamentals, as discussed above.

The earnings-related multiples remain are higher than they would otherwise be because special charges have not been excluded from earnings

The Price/Sales and EV/CFO ratios are both much lower than their historical averages.  These results helped the Value gauge score rise above last quarter's level.

Overall30 Jun 201031 Mar 201030 Jun 20095-yr Avg
Gauge Score (0 to 100)49432839

The Cash Management, Growth, and Profitability gauges didn't change appreciably in the second quarter, so the Value gauge was essentially responsible for the rise in the Overall gauge score. 

The Growth gauge is, by far, the weakest.  Improved Cash Flow from Operations (relative to a weak year-earlier period) kept this gauge from falling back towards zero.

The Cash Management gauge score benefited from improvements in the debt levels, inventory, and receivables.

Full disclosure: Long NOK at time of writing.

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