June 2, 2011 2 Comments
The following two measures give us a hint that Nokia might be cheap and due for a pull-back:
- The stock is down almost 40% year-to-date.
- The last closing price (6.57$) implies a yearly sales growth of -50% (using a reverse DCF).
It seems a bit extreme, so I decided to analyze the stock a bit deeper. Nokia is still the market leader after all! Unfortunately, a closer look shows that even at this price NOK is still not an attractive stock. Here’s why.
NOK business is under fire from all sides
On the smartphone front, Nokia is the underdog. Apple leads the pack, then we have Android phones getting traction, and finally "ex-leader" RIM desperately trying to hold its ground. At the bottom, there’s Nokia. Does this part need a longer explanation?
Nokia’s cheap phones are good products; however local producers are now hurting this part of their business. They create phones that are not necessarily better than Nokia’s, but that are more creative than Nokia’s pretty bland products. In developing Asia mobile phones are often bought to impress, and Nokia’s phones simply lack any "wow" factor. Moreover, mobile phones have become a commodity product, which means low margins and slowing growth.
Recovery hopes unclear
There’s a total lack of visibility about Nokia’s future business. They have a decent chance to stabilize their market share for cheap phones. It won’t be easy, and they’ll certainly continue to bleed market share for some time, but it can be done.
But future growth, especially earnings growth, will come from smartphones. We know that they’re going to use Windows Phone. Ask yourself: does Microsoft have a track record of successful mobile products? There’s the Zune, PDA’s (Windows Mobile) and phones (Windows Phone has 6% market share)… It doesn’t seem like a smart bet, right?
It appears that Windows Phone 7 is actually a pretty good product. But being a good product is not enough to be successful, and with all the momentum that iOS and Android have accumulated, Windows Phone might not be able to compete. We’ll see the actual Nokia products in October, before that date, gauging their quality is anyone’s guess. However, the market for this type of globalized consumer product is a "winner take all" type of market, which means that third prize is you’re fired. And the third place (or worse) is where Nokia is heading regarding smartphones.
This lack of visibility also explains why DCF based methods are currently useless to value NOK. Operating and profit margins as well as revenues are all changing too fast to make meaningful forecasts.
The business in numbers
- Profit Margin seems to be stabilizing at 5% against a historical median of 10%. It shows the commoditization of the mobile phone business and Nokia’s failure to get into the high margin smartphones. If Nokia continues to stay out of the smartphone market, then this will be their "new normal". It’s clearly not encouraging.
- All cash flow measures have been going down the drain. Sales conversion into OCF has reached 3% against a historical median of 12%, and OCF conversion into FCF has fell off a cliff.
- A ROIC of 8% is nothing to boast about, but it’s not bad either. The problem is that it has gone down for the past 4 years. CROIC (Cash ROIC, based on FCF rather than net income) is currently at 3% against a historical median of 26%. Now THAT has to hurt.
The efficiency measures are reaching worrying levels, and they are not stabilizing except PM and ROE. Nokia’s business ability to generate cash is severely challenged, it looks like it’s going to get worse before starting to improve.
NOK is NOT cheap considering the uncertainty
- PE of 9? Hewlett Packard (HPQ) is cheaper, and at least you’d have a stable business.
- EV/EBITDA of 4.9? That’s the price of a no-growth, utility type of business. Not the price of a "might enjoy negative growth for an unknown time" type of business. However, if you do believe in Nokia’s ability to get a foothold into the lucrative smartphone segment, then it’s an attractive price.
- ROE/PB: 10.4%. It looks good, but as a comparison, Microsoft has a ROE/PB of 10.3% and a competitive position that is still unchallenged; the exact opposite of Nokia.
- FCF yield (FCFe/P): 5.7%, around historical averages. So the equity of the business is not really selling at a discount, considering the uncertainty.
- Dividend yield: 8%, great but unsustainable, as dividends payments are eating more than twice the FCF.
Note: graphs represent past 10 years of data. Bold data is TTM, grey data is the median value.
A final note: NOK could reach the 5$ threshold pretty soon, and that would start a wave of forced selling.
All valuation measures available here: