12 February 2011

NOK: Financial Gauge Analysis for the December 2010 Quarter

Nokia Corp. (NYSE: NOK and HEL:NOK1V) earned 0.20 per diluted share on an IFRS basis in the December-ending fourth quarter of 2010, down 21 percent from €0.26 per share in the same three months of 2009. 

On a non-IFRS basis, which excludes special items, fourth-quarter earnings fell from €0.25 to €0.22 per share.
A previous GCFR article examined in some detail Nokia's Income Statement for the September quarter.  Reported earnings were €0.08 less than our €0.28 EPS estimate.

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.  The company also sells the network infrastructure that supports these phones. 

Nokia's sales, earnings, and share price have fallen precipitously in recent years.  In 2007, Apple's (NASDAQ: AAPL) iPhone was launched and quickly became a runaway success, one that Nokia has been unable to stem.  Smartphones based on the Android architecture and Blackberries sold by Research in Motion (NASDAQ: RIMM) have also become popular at Nokia's expense. 

In the latest and most dramatic (desperate?) attempt to regain its competitive position, Nokia in February 2011 entered into a strategic alliance with Microsoft (NASDAQ: MSFT).  Nokia will build devices that use Windows Phone software, allowing the company to eventually retire its widely used but aging Symbian mobile operating system.  An earlier Nokia plan would have established MeeGo as the company's future OS.

The Ovi service for selling handset software, once promoted as Nokia's answer to Apple's iPhone App store, will be integrated with Microsoft's online offering.

The alliance decision was made by Mr. Steven Elop, a Canadian citizen and Microsoft veteran that recently became Nokia's Chief Executive Officer.  Mr. Elop must be hoping that a deal with Microsoft will address Nokia's long-standing difficulties in the U.S.   As recently as January 2011, Nokia canceled the launch of a smartphone intended exclusively for the U.S. market.

Despite difficulties, 2010 was in some ways a better year for Nokia than the economically challenging 2009.  The overall profit attributable to Nokia shareholders rose to €1.85 billion, from €891 million in 2009.  Net Sales increased from €41.0 billion in 2009 to €42.4 billion in 2010.

Nokia has three main businesses:  Devices and Services (D&S), Nokia Siemens Networks (NSN), and NAVTEQ.  The latter is tiny in comparison to the first two.

D&S brought in Revenue of €29.1 billion in 2010, about 69 percent of Nokia's total, and it had an operating profit of €3.3 billion.

Revenue from Nokia Siemens Networks in 2010 was €12.7 billion, 30 percent of total Revenue.  However, NSN lost €686 million.  Nokia and Siemens (NYSE: SI) formed NSN as a 50/50 partnership in April 2007 to better compete in the network infrastructure market.

NAVTEQ's Revenue in 2010 was €1.0 billion, and it lost €225 million.  Nokia spent $8 billion to acquire NAVTEQ in 2007.

The price of Nokia ADRs has fallen about 75 percent from a $41 peak in late 2007.  The company's market value is now approximately $35 billion on a fully diluted basis.

Now we turn to the financial gauges.  The latest quarterly results produced the following changes to the scores:
  • Overall: 52 of 100 (down from 58)

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 Management31 Dec 201030 Sep 201031 Dec 20095-yr Avg
Current Ratio1.
LTD to Equity26.1%28.5%30.0%11.0%
Debt/CFO (years)
Inventory/CGS (days)27.627.428.227.1
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)65.567.777.264.2
Working Capital/Revenue20.4%19.6%15.4%17.5%
Cash Conversion Cycle Time (days)27.729.835.930.8
Gauge Score (0 to 25)17191510

The changes in the Cash Management metrics were generally minor in the third quarter, resulting in a steady gauge score.

Nokia had minimal long-term debt outstanding for many years, but this changed in late 2008 and early 2009 when the company issued much more debt than it had earlier.  In 2010, Nokia did not add to its long-term debt, but it didn't trim the amount outstanding by all that much either.  The company's Balance Sheet at the end of 2010 lists long-term debt of €4.24 billion, down 4.3 percent from $4.43 billion at the end of the previous year.

Despite the jump, Nokia's debt is still relatively minor.  In fact, the company holds significantly more cash and other liquid investments that it has debt.  When judged as a percentage of shareholders' equity, Nokia's long-term debt is fairly typical for a middle-to-large technology company.  In addition, the combination of long-term and short-term debt is not much more than the company's 2010 Cash Flow from Operations.

We've seen other cash-rich companies issue debt to help them manage cash flows and tax liabilities across numerous currencies.

Improved cash efficiency may be seen in the significant drops from the previous year in the Days of Sales Outstanding and the related Cash Conversion Cycle Time.

Nokia trimmed the number of days of Inventory held, after the Inventory level surged in 2008 and 2009.  By the measures we track, the inventory level remains modestly above long-term averages.

Growth31 Dec 201030 Sep 201031 Dec 20095-yr Avg
Revenue Growth3.6%0.3%-19.2%0.2%
Operating Profit Growth-41.4%-46.0%-33.2%-31.6%
CFO Growth47.0%174.1%1.6%-5.9%
Net Income Growth107.6%295.6%-77.7%-28.0%
Gauge Score (0 to 25)1917110
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.

Given Nokia's recent difficulties, the strong Growth gauge is counter-intuitive.  The high score is due to Nokia recording better results by some measures in 2010, in a few cases significantly, than it did in 2009.

The problem is that 2010 was better in part because 2009 was so bad.  For example, the third quarter of 2009 included a staggering €908 million intangible-asset impairment charge related to Nokia Siemens Networks. 

Revenue growth of 3.6 percent does not, by any means, qualify as robust, but the latest trailing-year rate appears stellar when compared to 2009's 19.2 percent drop in Revenue.

Revenue as percentage of total Assets also improved over the last year, but this ratio is well below its historical average at Nokia.  Nevertheless, the recent improvement had a significant positive effect on the Growth gauge score.

Cash Flow from Operations soared from €3.25 billion in 2009 to €4.77 billion in 2010. 

Profitability31 Dec 201030 Sep 201031 Dec 20095-yr Avg
Operating Expense/Revenue95.4%94.6%94.4%90.6%
Free Cash Flow/Invested Capital41.1%29.4%21.5%66.6%
Accrual Ratio-1.3%2.9%-0.6%0.5%
Gauge Score (0 to 25)1313812

The Profitability gauge did not change in the December 2010 quarter.

The continued decline of Nokia's operating margin (i.e., higher expenses relative to revenues) is a significant concern.  The lower margin is not due to special charges, which are excluded from the calculation

The Gross Margin has been trimmed from 34 percent of Revenue in 2008, to 32 percent in 2009, and 30 percent in 2010.

 Return on Invested Capital and its Free Cash Flow equivalent are both much higher than they were one year earlier.  Of course, neither return approaches its five-year average.  The FCF/IC ratio is high enough to give a significant boost to the Profitability score.

Value31 Dec 201030 Sep 201031 Dec 20095-yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)6.58.413.614.3
Gauge Score (0 to 25)1013118
Share Price ($)$10.32$10.03$12.85-

The price of Nokia ADRs was steady in the fourth quarter.  However, the Price/Earnings multiple still expanded, which put downward pressure on the Value gauge.  Since earnings fell in the quarter, the price would have needed to decline to help the score.

The P/E has been somewhat inflated by special charges, but it still seems high given current market conditions and the limited expectations for future earnings growth.

The Price/Sales and EV/CFO ratios roughly half their long-term averages.  These low figures put a floor below the Value gauge score.

Overall31 Dec 201030 Sep 201031 Dec 20095-yr Avg
Gauge Score (0 to 100)52584039

The Overall gauge lost 6 points in the quarter, probably less than what might have been expected.  Debt and inventory levels steadied, which limited the downward movement of the Cash Management gauge.  The Growth gauge, which reacted positively to improvements in the last year relative to the previous one, lent significant support to Overall score.  The Profitability gauge gave enough credit to improved returns on investment to offset the worrisome decline of Nokia's operating margin.

Keep in mind that the 2010 figures benefited to some extent by how much Nokia struggled in 2009.

Full disclosure: No position in NOK at time of writing.

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