Nokia Rises On Profit Beat, China Growth, Even As North America Struggles

+13.48%
Upside
3.54
Market
4.02
Trefis
NOK: Nokia logo
NOK
Nokia

The key highlights of Nokia‘s (NYSE:NOK) Q3 earnings were the significant sequential improvement in Networks’ operating margins and its $4.4 billion capital distribution announcement. Following a lackluster Q1 and a relatively better Q2, the company reported its Networks operating margins at 13.6%, beating analysts’ expectations of 10.2%. [1] While the year over year (y-o-y) improvement in margins was just 10 basis points, the sequential improvement was over 2 percentage points, thanks to an improvement in mobile broadband gross profit rate (non-IFRS) and lower operating expenses. [2] Even after reporting Networks’ operating margins of just 3.2% in Q1, Nokia was confident about meeting its annual target of 8%-11%. And considering the Q3 performance, the company appears well on its way to doing so.

Another highlight of the quarter was Nokia’s performance in China, which remained solid despite the recent slowdown in 4G rollouts that troubled Ericsson (NASDAQ:ERIC). In fact, China was the only market where the company registered a notable y-o-y increase in sales, while its growth in other major markets such as North America and Europe remained negative. It appears that the sluggish improvement in carriers’ capital spending is weighing heavily on the network infrastructure industry.

Nokia’s net sales for the third quarter were down 2% y-o-y  to EUR 2.87 billion due to significant sales decline in North America and Europe, partially offset by strong growth in China. Mobile broadband sales were down 6% due to a tough comparable period and lower sales in radio technologies, while global services was up 3% on account of growth in systems integration business line. Networks operating profit was down 2% y-o-y to EUR 391 million, but it was a long way ahead of the expected EUR 297 million. Following the earnings release, Nokia’s shares jumped 10%.

Relevant Articles
  1. Is Nokia Stock A Buy At $4?
  2. Nokia Stock Looks Undervalued At $4
  3. Nokia Stock Poised For Recovery After Dismal Week?
  4. Nokia Stock Looks Set For Rally After Rough Month
  5. Can Nokia Stock Continue Weathering The Storm In The Broader Markets?
  6. Can Nokia Stock Continue Its Post-Earnings Outperformance?

Our $8 price estimate for Nokia is around 8% higher than the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Nokia stock here

Networks Margins Expand Well

Operating margins for the Networks segment, the main segment for Nokia, expanded around 2 percentage points sequentially driven by higher operating profits in mobile broadband, partially offset by lower operating profits in global services. Even though the proportion of high margin software sales was down in Q3 as compared to Q2, strong contribution from overall radio and core networking technologies, and strength in systems integration business line helped Networks’ gross margins. While the segment’s gross margins shrunk 50 basis points sequentially, a significant decline in operating expenses more than made up for it.

With a continued focus on cost efficiency, Nokia was able to bring down its R&D expenses, and lower personnel expenses and operational improvement resulted in a decline in SG&A expenses. It is important to note that foreign exchange fluctuations had a marginal negative impact on operating profits, and yet the sequential improvement was impressive. There was even some y-o-y improvement in operating margins, thanks to gross margins expanding 40 basis points on an annual basis. [2]

Much of the recent improvement in margins came from control in costs, which clearly indicates that Nokia’s efforts of optimizing its operations are progressing well. The company’s eight strategic initiatives aimed at improving productivity, efficiency and cost intensity, and streamlining site strategy, supply chain transformation, headcount control and IT operations appear to be yielding some promising results. While it is likely that Nokia can maintain a firm control on its expenses, low-margin deals in China will definitely have a negative impact going forward.

China Works Better For Nokia Than It Did For Ericsson

While strategic deals in China may have a negative impact on Nokia’s profits, it is a crucial market for the company from a top line perspective. During the third quarter, Nokia’s sales from Greater China increased 27% while they were significantly down or flat in other markets. What’s even more impressive about the company’s China performance is that it was able to register strong growth in the market despite the recent slowdown in 4G rollouts. Just a few days ago, Ericsson mentioned in its Q3 earnings that the management reshuffle among Chinese operators led to a slowdown in 4G deployment during the third quarter. [3]

However, it acknowledged the stability in underlying 4G demand, which Nokia appears to have exploited well. While Ericsson’s projects in China are coming to an end, Nokia’s are continuing, which somewhat explains the difference in performance. Looking ahead, 4G penetration in China remains low at 20%, which bodes well for Nokia. However, the market is expected to slow down further next year. [1]

North America Disappoints, But Nokia Has Alcatel-Lucent

While the performance in China was strong, Nokia’s performance in North America was disappointing, as sales from the region fell 19% y-o-y, raising concerns around the overall telecom gear industry. Although the company attributed its weak performance to a tough comparable period, the industry weakness cannot be ignored. Firstly, major carriers in the U.S. have not increased their overall capital spending much over the past year, and when they have it has been primarily for spectrum auctions and deals.

This does not paint a great picture for Nokia, but the good news is that it is merging with Alcatel-Lucent, which will position it among the top players in the telecom gear industry. Management mentioned recently that the merger is progressing very well, having received several regulatory clearances. In fact, in preparation for the shareholder meeting next month for the approval of the deal, Nokia announced that it would pay investors around $4.4 billion cash in the coming years, in the form of buybacks and dividends. [4] This should help elevate investors’ confidence in the company as well as the deal.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Nokia beats estimates and returns cash, Alcatel deal on track, Reuters, Oct 29 2015 [] []
  2. Interim Report for Q3 2015 and January-September 2015, Nokia, Oct 29 2015 [] []
  3. Third Quarter Report 2015, Oct 23 2015 []
  4. Nokia to distribute $4.4 billion among shareholders as sales dip, Economic Times, Oct 29 2015 []