re: Morningstar on Nokia
>> Morningstar Quicktake® Report on Nokia ADR (NOK)
07-08-2002
by Todd P. Bernier
The wireless industry has more competition than ever, which is enough to keep us away from Nokia.
Nokia announced in mid-June that second-quarter sales would decline--not grow, as expected--2%-6% from last year's second period. The pain was worsened a week later when management ratcheted down sales forecasts for this year's second half. Although Nokia's dour outlook shocked Wall Street, we predicted such sobriety: There is currently no catalyst for growth.
The fundamental problem is that global demand for cell phones is falling. We think that Nokia's estimate of 400-420 million phones is off the mark, and that roughly the same number of phones will be sold this year as last (380 million). Carriers have cut handset subsidies in quest of profits, and handset replacement cycles have lengthened. Without a compelling reason to upgrade, consumers are holding on to their current phones.
Although Nokia does cell phones better than any other company, it has dropped the ball in terms of product launches. For instance, Sony Ericsson scored a major hit with the color T68, and Motorola MOT has taken the early lead in 2.5G technology. Finally, Nokia is irrelevant (less than 10% market share) in the fast-growing CDMA segment, dominated by Korean manufacturers Samsung, LG Electronics, and Kyocera KYO. Although these miscues won't significantly affect sales, it must be painful for Nokia to watch rivals steal its thunder.
It is even worse in wireless infrastructure, where sales are now expected to decline much more than initially forecast. Nokia's customers are cash-strapped, debt-laden carriers whose own viability is in question. Spending heavily on their networks, particularly for next-generation gear, is the last thing that they are able to do.
In our last analysis we cut forecasts for growth and margins, the two key profit levers, which materially reduced Nokia's fair value estimate. Because we were so bearish then, there is little for us to change this time around. It would be easy for us to lop another $1 off the fair value estimate, but that would be splitting hairs; we wouldn't buy Nokia until a large margin of safety exists to our fair value calculation, be it $13 or $14.
In our opinion, Nokia will never revert to its hypergrowth past. We will avoid Nokia until phones are flying off the shelf again, or until the shares become unavoidably inexpensive.
Strategy
Nokia is the king of cell phones, capitalizing on its powerful brand to introduce desirable new phones. Thinking like a consumer goods company, Nokia has segmented the market by providing different phones for different consumer categories. Management has put pressure on rivals who cannot match Nokia's marketing prowess and efficiency, in the process grabbing share.
Management
Chairman and CEO Jorma Ollila is credited with reversing Nokia's fortunes in the early 1990s by transforming it into a wireless-only company. Management is considered to be very stable, with most of the top positions dominated by veteran "Nokians."
Profile
Nokia is the world's top maker of mobile phones, which accounted for roughly 75% of the firm's top line in 2001. At a time when the market for mobile phones is becoming saturated, Nokia is aggressively winning share from ailing rivals by cutting prices and launching many new models. The company's other main business is supplying telecom infrastructure gear to wireless carriers, a segment dominated by Sweden's Ericsson. Nokia hopes to eventually have 30% share in this market.
Close Competitors TTM Sales
TTM Sales Market Cap
($Mil) ($Mil)
Nokia 29,994 68,445
Lucent Technologies 18,136 6,983
Nortel Networks 17,511 4,958
Ericsson Telephone 25,418 13,469
Motorola 28,342 33,154
Morningstar Stock Grades for Nokia and Nokia Industry Peers
01 Sales Financial
$Mil Growth Profitability Health
Nokia ADR 28,291 A+ A+ A
Ericsson 25,418 A A C+
Motorola 28,342 C C D
Qualcomm 2,702 C B- A+
Data as of 07-09-02
Valuation
The shares trade close to our fair value estimate, meaning there is an insufficient margin of safety to warrant purchase. In our view, Nokia won't look interesting again until the shares trade at a deep discount to our fair value estimate or top-line growth resumes.
Growth
Nokia was once a growth machine, but not anymore (sales fell 20% sequentially in the March quarter). Sales projections continue to fall; management expects 10% annual growth in the third and fourth quarters, resulting in zero overall growth this year.
Profitability
An ability to charge premium prices, coupled with lean production expenses, have kept Nokia's margins high. However, we fail to see how this can be sustainable in an era of mature markets, cutthroat pricing, and Microsoft.
Financial Health
Nokia is a cash-generating machine, and carries more than 6 times as much cash as debt. Its debt/equity ratio is less than 0.1.
Morningstar Risk: Medium
Economic Moat: Narrow
Stock Price: $14.50 as of 07-08-2002
Morningstar Fair Value: $14.00
Morningstar Rating: Three Stars 07-09-02
Bulls Say
* Nokia is mobile phones. Despite losing some market share recently, Nokia still has twice that of second-place Motorola. Consultant Interbrand rates Nokia as the world's fifth-most valuable brand; Nokia can't easily be displaced from the throne.
* While rivals bleed red ink, Nokia earns operating margins in excess of 20%. As a result, Nokia is a cash flow machine.
* Nokia's balance sheet is nirvanalike--cash exceeds debt by 6 times--compared with those of highly indebted rivals. This removes any threat of insolvency, and will allow Nokia to acquire others affordably. Ericsson, for example, may be for sale.
* New models should prevent average selling prices from eroding. Also, the upcoming launch of the 3510 model could trigger growth in the mass-market segment, which has been largely vacated by struggling rivals.
* Nokia is making strides in CDMA phones, the one area of the cell phone market where it didn't have much of a presence.
Bears Say:
* The wireless handset industry is in a funk; little growth is projected for 2002. This is partially due to the debt-laden carriers' decision to reduce handset subsidies, which limits customer growth.
* Retail prices for handsets have nearly been halved over the past five years. Unless newer, more complex phones are a big hit, price erosion will continue, especially with the entry of several low-cost Asian manufacturers.
* A couple of giants, Microsoft MSFT and Intel INTC, are pushing hard for a common technological blueprint, thus allowing any consumer electronics maker to easily produce cell phones. Should this occur, Nokia's fat profits are history.
* Demand for wireless networking gear is dead right now, as cash-strapped carriers defer the purchase of new equipment.
* Nokia had more than $1 billion in vendor financing at the end of March. Although vendor financing juices sales, it creates default risks.
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- Eric - |
