ML:Growth Remains Intact,reits BUY, tgt $76
Excerpts from Merrill Lynch
12 Month Price Objective: EUR80/$76
Investment Highlights:
• We re-iterate our Buy on Nokia following the
recent share price correction.
• We are lowering our 2000 estimate from
EUR0.79 to EUR0.77 due to an expected 300
basis points decline in Mobile Phone handset
margins in Q3 to 18.9% (EPS for 00Q3 goes to
EUR0.15 from EUR0.19).
• We are maintaining our 2001 estimate of
EUR1.06, as we believe Nokia will get back on
track both in terms of handset margins and
new model launches by year-end.
• At 42X 2001 estimates and a PEG of 1.8 versus
peer average of approximately 1.9, we believe
Nokia is an attractive investment.
Fundamental Highlights:
• We believe Nokia’s handset business will gain
share in 2H of year, reaching our 33% market
share estimate.
• New models in low, medium and high end
bracket should improve mix in 00Q4.
• We believe the likely shortfall in 00Q3 results
will be a one-off and that management will
execute and regain market confidence in the
near future.
What Has Changed?
Nokia reported Q2 results that were in line with street
expectations. As a result of meeting expectations rather
than beating them and a warning on Q3 results, the
stock tumbled more than 20%. We believe that the
market reaction is overdone. We believe management
execution in rest of year will not disappoint and we
expect the mobile market to be bouyant in 2001. We
have, however, reduced our 2000 EPS estimate by 3%
to EUR0.77, but are maintaining our 2001 estimate at
EUR1.06. We maintain our Buy recommendation on
the stock.
Our Thoughts . . .
In our opinion, one of the main concerns in the market for
Nokia is that mobile phone demand is slowing and that the
company could be turning ex-growth as the mobile phone
market follows the trend in the PC market. We do not
believe this is the case. Nokia's warning yesterday was all
about execution and nothing about market growth. We are
confident that mobile phone sales will continue to be
strong in the second half and throughout 2001, barring any
future component issues.
We have revised our numbers and believe that Nokia will
gain market share in units this year and get to
approximately a 33% share of the global market with
around 140 million units (80% unit increase year on year).
In 2001, we believe handset unit sales for Nokia will
increase by 50% to 205 million units which will be
approximately a 34% market share next year.
The other market concern is that the mobile handset
business will commoditise like the PC industry. In our
opinion, there are some subtle differences between these
two industries. Firstly, the likes of the Dells and Compaq’s
have focused on the hardware design and distribution of
these products into the market. The software, applications
and operating systems (OS) have come from other
vendors. In the case of mobile handsets we have started to
see that many of the handset vendors are increasingly
investing in software, OS and applications architectures.
Nokia has been doing this for quite some time and we
believe that this is an area of strategic importance for the
company. Secondly, we do believe that the devices will get
more intelligent than they are today and this will aid in
keeping ASP declines from falling of a cliff.
Nokia Mobile Phones has also internally split itself into
two divisions to focus on:
• Mobile voice handsets with limited data capability;
these are products such as the 7110, 6210 and 6250
• Mobile multimedia devices with voice as a core
constituent. These are products such as a Palm user
interface on a Nokia platform.
In our opinion investments have been made into this
multimedia area which will position Nokia well to take a
substantial market share which we are expecting at the
20% level. These products will not kick in though until
2002.
Why is Nokia being so aggressive on Pricing in Q3?
In our opinion, there have been some issues in R&D
regarding greater software portion being added on to the
devices. This has caused new release shipments to be
pushed back by a few months on certain products. We
believe that these products are now to be delivered at
different points in Q3. Due to these shipment delays, we
believe that management has made the decision to focus on
market share gains with its existing product line.
Competition especially at the lower end has been
aggressive with product introductions and pricing. In order
for Nokia to achieve its market share gain targets, we
believe that it has decided to reduce ASPs on its older
product range such as the 3000 and 5000 series.
We do believe however that a surprise may be in order at
some point in time in Q3 (ramp up phase for new
poroducts) with the introduction of new handsets aimed at
the low end. These will impact margins in Q4 positively.
In terms of new versus old mix. Traditionally with Nokia,
30% of handsets are new models in the mix. In Q3 we
expect this number to be below 10% and ramp up to above
35% in Q4. Execution is going to be critical here, any
slippage will signify margins and potentially revenues
moving into the subsequent quarter. Management has been
excellent in execution with few mishaps. Recently, there
have been some signs such as CDMA handset portfolio
issues and WAP delays (7110) that may create a
perception of management execution issues. We believe
though that the company has a pipeline ready to roll out in
these various areas over the next few months.
We believe that the market wants more visibility on
product roll-out and we believe that this visibility will start
to appear in Q3 with the new products roll out across the
various end customer segments (low, mid-range and high-end).
Results Summary
Nokia reported Q2 results that were roughly in line with
our expectations. Net sales came in at EUR 6.98 billion, or
55% up from the corresponding quarter last year. Group
Operating Profit increased by 60% to EUR 1.4 billion (or
20.2% of sales) with EPS of EUR0.20, a penny ahead of
our numbers.
Nokia Mobile Phones saw 67% revenue growth with
operating margins of 25% (compared to our forecasted
23.4%). The division is preparing for the release of a new
product portfolio in the second half of this year in GSM,
TDMA and (importantly) CDMA markets. The new WAP-enabled
6210 handset is already starting to ship and a clear
roll out schedule for the next two quarters is in place.
Sales in Nokia Networks increased by 38% with margins
in line with our forecasted 18%. Nokia Networks
continued to strengthen its position as the second best
wireless infrastructure business in the industry. The
division has already delivered its GPRS core network
solution to over 40 operators world wide and continues to
broaden its existing position in GSM networks, highlighted
by its $900 million contract win with Telsim in Turkey
(the division’s largest infrastructure deal to date).
Financials
In 2000, our Group operating margin estimate has been
reduced to 18.4% from 19.7%, primarily due to our
downgrade on Nokia Mobile Phone margins to 22.1%
from 23.2%. This margin decrease results from Nokia's
intention to lower prices in Q3 in order to fend off strong
competition and increase its market share during a time
where the majority of their offering is based on older
platforms. The number of Nokia new product launches in
Q3 will be lower than anticipated due to some production
delays, which means Q4 should be extraordinarily strong
for new products launches and profitability.
We believe that Nokia will introduce phones across low,
mid and high ranges during Q3 that will improve margins
in Q4 to 21.1%
For 2001, we have no change in estimates. We maintain
that Nokia Mobile phone margins will decline to 21.7%,
while its Networks division margin should hold at 18.1%.
We believe handset unit sales will increase by 50% to 205
million units.
Outlook
Nokia is currently trading at 42X our 2001 estimate or on a
PEG of 1.8. The average for the comms group is 1.9. We
believe the leaders in the comms group deserve to trade at
between a PEG of 2.75 and 3. Nokia is the global leader in
handsets (and getting stronger) and the 2nd best vendor in
mobile infrastructure. We re-iterate our Buy rating on
stock with a Price Objective of EUR80.
Table 1: European Telecom Valuations
Growth PE PE 2000 P/E to 2001 P/E to
Companies Rate % 2000 2001 Growth Growth
Alcatel Alsthom 20.00 66.6 38.7 3.33 1.94
Ericsson 25.00 66.9 45.2 2.67 1.81
Marconi (March) 17.50 54.4 45.3 3.11 2.59
Nokia 25.00 61.2 44.3 2.45 1.77
Philips 12.50 16.3 16.1 1.30 1.29
European Average 20.00 53.05 37.94 2.57 1.88
Global Average 23.32 56.68 43.83 2.38 1.87
Source: Nokia/ML estimates
Table 2: Nokia P&L (EUR mn)
Nokia P&L (EUR mn) 1998A 1999A 2000E 2001E
Mobile Phones 8,070 13,182 21,240 29,000
Networks 4,390 5,673 7,500 9,950
Nokia Ventures 1,014 995 950 1,200
Inter Group (149) (78) (100) (125)
Group Total 13,326 19,772 29,590 40,025
Cost Of Sales (8,299) (12,227) (18,315) (24,650)
Gross Profit 5,027 7,545 11,275 15,375
R&D (1,150) (1,755) (2,702) (3,550)
S, G & A (1,388) (1,811) (3,000) (3,850)
Amortization of Goodwill (71) (120) (150)
Operating Profit 2,489 3,908 5,453 7,825
Mobile phones 1,540 3,099 4,700 6,300
Networks 960 1,082 1,360 1,800
Nokia Ventures (338) (200)
Common Group expenses (11) (273) (269) (75)
Associated Co 6 (5) 0 10
Exchange Gains 0 0 0 0
Net Int / Other Fin Expenses (39) (58) 47 20
Total Financial Expense (39) (58) 47 20
Pre-tax Profit 2,456 3,845 5,500 7,855
Tax (737) (1,189) (1,706) (2,514)
Minorities (39) (79) (111) (150)
Profits From Cont Ops 1,680 2,577 3,683 5,191
Profit Before Acc Changes 1,680 2,577 3,683 5,191
Cum PY Effect of Acc Chng 70 0 0 0
Net Profit 1,750 2,577 3,683 5,191
Shares (’000) 4,693 4,737 4,800 4,900
EPS (Euro) 0.36 0.54 0.77 1.06
EPS (USD) $0.41 $0.56 $0.75 $1.10
Exchange Rate (USD/EUR) 1.14 1.02 0.98 1.04
Source: Nokia/ML estimates
Table 3: Nokia Margin Analysis
Margins 1998A 1999A 2000E 2001E
Gross margin 37.7% 38.2% 38.1% 38.4%
R&D as % of sales -8.6% -8.9% -9.1% -8.9%
SG&A as % of sales -10.4% -9.2% -10.1% -9.6%
Operating Margin % 18.7% 19.8% 18.4% 19.6%
Mobile phones 19.1% 23.5% 22.1% 21.7%
Networks 21.9% 19.1% 18.1% 18.1%
Nokia Ventures Na Na -35.6% -16.7%
Pre-tax margin 18.4% 19.4% 18.6% 19.6%
Tax Rate % -30.0% -30.9% -31.0% -32.0%
Net margin 12.6% 13.0% 12.4% 13.0%
Source: Nokia/ML estimates |
