Nokia Earnings Preview: Networks Revenues To Drive Growth, May See Pressure On Bottom Line

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Nokia (NYSE:NOK) is scheduled to release its Q2 results on Thursday, July 30. We expect its overall operational sales to improve year-over-year (y-o-y) on account of strong Networks sales, which contribute about 90% of total revenues. [1] The company has built a strong pipeline of orders on a number of contract wins in the U.S, Europe, India and China, with carriers such as T-Mobile (NYSE:TMUS), Sprint (NYSE:S), China Mobile (NYSE:CHL), China Telecom (NYSE:CHA), Vodafone, Bharti Airtel and Mobily increasing their network spending. In the previous quarter, Networks sales increased by 15% y-o-y on a constant currency basis to EUR 2.67 billion ($3 billion), driven by solid growth in global services and a moderate increase in mobile broadband sales. [2]

However, Nokia’s bottom line may be under pressure on account of lower-margin LTE deals in China. In fact, in the last quarter, the company missed estimates on profitability, as its core Networks business reported weak profits and management lowered its full-year profit forecast for the division. Networks’ operating profits declined 61% y-o-y in Q1 and the company-wide adjusted operating margin shrunk 550 basis points to 8.3%. [2] For the full year 2015, the company expects the Networks operating margin to be near the mid-point of its long-term range of 8-11%, which is likely to be the case in Q2 as well.

Nokia’s other businesses – global mapping division HERE and the Intellectual Property (IP) licensing division Nokia Technologies – are likely to report strong top-line gains, in line with their recent performances. In Q1, HERE revenues were up 17% y-o-y to EUR 261 million ($294 million) and Nokia Technologies revenues jumped a staggering 96% y-o-y to 266 million ($300 million) on account of higher income from certain licensees including Microsoft (NASDAQ:MSFT), and certain one time adjustments to accrued net sales from the existing agreements. On the profitability side, Nokia raised HERE’s operating margin target for 2015 from 7-12% to 9-12%, expecting continued strong bottom-line performance from the division.

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Our $7.50 price estimate for Nokia is around 15% higher than the current market price.

See our complete analysis for Nokia stock here

Networks Revenues Turned Around In 2014 

The sale of the handset business made Networks (formerly NSN) the biggest contributor to Nokia’s value, accounting for almost half of its total value by our estimates. Before being promoted as Nokia’s CEO, Rajeev Suri headed the Networks division for the company. At the helm of NSN, Suri is credited with turning the division around to sustained profitability on the back of a big restructuring program that cut its operating expenses by EUR 1.35 billion and increased its focus on mobile broadband. However, the transition took a toll on Nokia’s top line, which declined by 17% y-o-y in the first quarter of 2014 as the company exited unprofitable service contracts, primarily in EMEA and Latin America.

In the next nine months, the company was able to reverse much of its top-line decline by banking on higher LTE spending across geographies, especially North America, Greater China and Asia-Pacific. Excluding the impact of divestitures, contract exits and currency fluctuations, Nokia’s Q2, Q3 and Q4 2014 Networks revenues grew by 1%, 15% and 8% y-o-y, respectively, compared to a decline of 6% in Q1 2014 and 22% in Q4 2013. This growth momentum continued in the first quarter of 2015 with a 15% rise in revenues, though much of it can be attributed to a weak comparable period.

In the first quarter,  Networks’ robust revenue growth was driven by solid growth in global services (21%) as well as mobile broadband (10%). In terms of geographies, the Asia-Pacific region, contributing 33% of sales, reported a growth of 14% y-o-y in sales driven by robust business activity in India, partially offset by lower mobile broadband sales in Japan. North America reported the fastest sales growth of 47% in the quarter, driven by solid global services sales, including the benefit from the acquisition of SAC Wireless last year.

Strong Order Pipeline To Boost Networks Sales In Q2

Going forward, rising 4G LTE deployment activity should continue to help Nokia improve revenues further. Nokia has done well in winning LTE contracts with China Mobile and China Telecom, and has emerged as one of the leading foreign players in the Chinese LTE buildout. Although European sales have been slow to recover, the deal pipeline looks strong as carrier spending is likely to return. In addition to the company’s recent contract with T-Mobile, its contract win at Sprint is also likely to boost revenues in the near term, with the carrier likely to splurge on its Spark program now that its initial LTE layout is complete.

India is also a very important market for Nokia, where it had a very strong 2014. It ended last year with over 34 deal wins for services including modernization of 2G and 3G networks, 4G deployment, WiFi solutions, security solutions and device management. With this, Nokia led the country’s 4G LTE market in terms of contract wins last year and was also the market leader in 2G, 3G, managed services and GSM-railways. Some of Nokia’s latest deals include a $200 million contract from market leader Bharti Airtel to build India’s first 4G network, a 4-year deal with Bharti Airtel to deploy 3-G networks in five new circles, a five-year contract with Vodafone for the modernization of its radio access network (RAN) equipment, and a three-year network upgrade deal with India’s third largest carrier Idea Cellular. [3] Following these deals, Nokia is now working with Vodafone in 19 out of the 22 telecom circles in India, and has also become the biggest equipment provider to Idea Cellular in the country (also read Can Nokia Take Advantage Of India’s Shift To 4G?).

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Notes:
  1. Results & Reports, Nokia []
  2. Q1 2015 Presentation, Nokia, April 30 2015 [] []
  3. Airtel gives 4-G 3G network deal to Nokia Networks, Economic Times, Jun 30 2015 []