EUR 850.00 For Business Accounts Only

Morningstar | NOKIA Updated Forecasts and Estimates from 17 Sep 2018

Nokia continued its struggle into the second quarter of 2018, with a slightly above-consensus top line completely overshadowed by lackluster margins. According to management, the main culprits for the margin compression were the Big 4 North American wireless carriers. While these carriers have always wielded significant buying clout that has allowed them to demand concessions from equipment suppliers like Nokia, management indicated that there has been a material increase in the pricing pressure exerted by these customers so far in 2018. These developments dovetail well with our long-term view of the firm’s competitive positioning. We maintain that a lack of negotiating leverage, combined with intense price competition from Chinese competitors and secular shifts in the network infrastructure used by telecom players, will hinder margin expansion and preclude Nokia from generating economic profits over a full business cycle. Consequently, we are maintaining our no-moat rating for this name, as well as our fair value estimate of $5.50 per U.S. ADR and EUR 4.50 per share, and view shares as fairly valued at current levels. We also maintain our stable moat trend rating, as encouraging signs from other areas of the business such as software and optical networks give us confidence that the company will be able to maintain its competitive standing.

Revenue fell 5% year over year to EUR $5.3 billion. This was driven by a 6% sales decline in the networks segment, though management pointed out that the segment’s revenue was flat on a constant-currency basis. Overall gross margins tightened 480 basis points to 35%, as large customers pushed back on Nokia’s pricing. Management has noted that as 5G deployments pick up in the third and fourth quarters, margins are expected to improve. We have seen evidence of 5G spending ramping up across our telecommunications coverage, and thus expect to see slight sequential improvements in margins going forward.

In the technology segment, revenue fell year over year by 2% to EUR 361 million. As management continues to commit capital to software and IP development, we believe that these high-leverage and high-margin businesses will be able to modestly offset the competition and pricing headwinds from the networks side.

Nokia’s optical networks business grew 7% in the quarter to EUR 365 million. The firm has said it is taking share in this space, and management views consolidation among service providers favorably. In our view, however, further consolidation will eventually lead to the kind of pricing pressure that has manifested in their wireless equipment business. This will also be exacerbated if the secular trend of convergence between wireless and fixed-line services continues around the globe, as we think it will. Additionally, while geopolitical factors have hampered competitors such as Huawei and ZTE in the short term, we continue to view these players as existential profit threats outside of the North American telecommunication market.