Glass Half Full? Nokia's U-Shaped Recovery
Dec. 13, 2016 5:06 AM ET|1 comment | About: Nokia Corporation (NOK)
D.M. Martins Research D.M. Martins ResearchFollow(1,122 followers)
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Summary
NOK has recovered strongly over the past month, since its November Capital Markets Day presentation.
U-shaped recovery: company sees a challenging 2017 and a recovering 2018-2020.
Plugging in the numbers: armed with more information, I revisit my projections.
Nokia (NYSE:NOK) has cracked open the black box and shed some light into management's expectations for the next 5 years.
As I have noted in my previous articles, the company has been criticized for being vague on its guidance. I believe this lack of specificity has been one of the reasons driving investors to the sidelines. As a result, shares have plunged even as Nokia continued to largely meet quarterly expectations.
But that approach started to change after Nokia's November 15th Capital Markets Day, its first large-scale, day-long meeting with analysts since 2014 - and only the second since 2009. Management came forward and shared its vision for the company, along with some of their own projections through 2021. Shares have steadily rallied 14% since then.
Source: nokia.com
The timing of this event couldn't have been better, in my opinion. When uncertainty and fear are dominant forces in an unstable industry like communications equipment, the Street finds comfort in participating in a conversation about the path forward.
In this article, I will explore some of my key takeaways from what Nokia's top management team shared last month. Later this week, I will zero in on a topic that I find increasingly central to Nokia's long-term success which, I believe, many have been ignoring or underestimating.
A "u-shaped" recovery
CEO Rajeev Suri made it clear that 2017 will be a year of slowing deterioration and inflection for Nokia - but certainly not one without its challenges.
Within the company's primary market - namely fixed and mobile networks; IP and optical networks; and applications and analytics - the CEO estimates that the total market should once again shrink next year, from EUR 113 billion to EUR 110 billion. But the 2.2% YOY drop, better than this year's 5% market contraction, should give way to a 1.2% annual market expansion through 2021, as the chart below suggests. This modest bounce back can be partly attributed to an increase in demand for data, over the next five years, that Nokia estimates will not be met with what the infrastructure currently has to offer.
Source: Montage using graphs from Nokia's Capital Markets Day presentation
Although not necessarily an encouraging prognosis of where the industry might be heading, Nokia's management team has committed to driving higher growth for its Networks division compared to the primary market, at least over the long run. For 2017, however, management's expectations are for a performance in line with that of the market, which is more than likely to exceed what Nokia has been able to deliver in 2016 (revenue contraction of -11% YTD in the Networks division) by a good margin.
Part of the reason behind Nokia's long-term optimism rests on the company's planned expansion into vertical markets. These adjacencies - namely the couple dozen large webscale players plus enterprise clients in sectors like energy and transportation - are expected to remain in a much better place in regards to capital investments than traditional telecom carriers over the next few years. In fact, Nokia projects this niche market outside the telco domain to grow by nearly 13% each year, on average, through 2021.
Source: Nokia's Capital Markets Day presentation
Plugging in the numbers
Nokia's CFO Timo Ihamuotila also took the stage at Capital Markets Day to provide more color around the company's projected results over the next few years. A couple of interesting data points were shared.
First, despite the challenges of 2017, cash flow from operations is expected to come in strong, within a range of €2.5 billion to €3.0 billion. Nokia also disclosed its intention to pay approximately €1 billion in dividends next year which, at the current diluted share count, points to a very attractive dividend yield of 3.7% on a cash flow generation platform that I consider solid.
Source: Nokia's Capital Markets Day
Second, I was also pleased to see that once outflows associated with restructuring start to taper off, FCF (free cash flow) is expected to turn clearly positive in 2018 vs. slightly positive in 2017. This trend bodes very well for the company, as it can continue to execute on initiatives like cash distribution to shareholders, debt repayment, and strategic M&A activity - like the 2016 acquisition of personal health technology company Withings.
Third, previously-disclosed guidance for next year and through 2018 were reiterated. Armed with the different pieces of the puzzle, I revisited and fine-tuned my base-case estimates. As the table below suggests, I believe Nokia will continue to face challenges to drive top- and bottom-line momentum over the next couple of years.
Source: DM Martins Research, using data from Company reports
Stay tuned
So far, my takeaways from Nokia's Capital Markets Day have pointed to a scenario of continuing deterioration and challenges in the short term. This should not catch by surprise those who have been following the recent evolution of the communications equipment sector.
The longer-term outlook, however, looks a bit more promising - if Nokia can execute as well as management expects it to. I believe the company has a few cards to play even within its battered Networks business (expansion in the enterprise segment, shift to standalone software, 4.9G and 5G, macro recovery) as it orchestrates its slow, u-shaped turnaround.
The other potential driver of longer-term growth will be the subject of my next article. Misunderstood and often underestimated, I see meaningful potential upside coming from Nokia's Technologies division. More than simply a portfolio of patents, I believe this segment could become an interesting contributor to Nokia's bottom line in the future - one that many investors don't spend enough time talking about.
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Disclosure: I am/we are long NOK.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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