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There’s a simple reason to avoid Nokia (HE:NOKIA): it’s burned too many investors too many times. Over the past decade, NOK has gained a little over 19%. Even including dividends, annualized returns are less than 4%. It’s not for lack of trying or a lack of opportunity.
After all, Nokia was on the right side of one of the best deals in recent corporate history when it sold its phone business to Microsoft (NASDAQ:MSFT) in 2013. (Microsoft paid Nokia $7.2 billion and sold the unit three years later for just $350 million.) It executed one of the largest mergers of the 2010s by uniting with Alcatel-Lucent (EPA:ALUA).
There have been cost-saving programs and a push into software, and myriad promises to improve execution. Nothing has worked.
To be sure, on occasion, there have been signs of progress. Nokia stock has posted fairly regular rallies, and the business has shown signs of driving consistent growth. In 2017, for instance, adjusted earnings per share increased 50% year-over-year. The following year, profits declined, and in 2019 NOK plunged 36.2%.
Nokia is showing signs of progress again — but investors, perhaps due to that history, remain wary. There are some good reasons for that, but at the same time, there is a case that for Nokia, this time might finally be different.
One core reason for considering NOK here is that, fundamentally, the stock looks like a steal at the moment. Backing out nearly $1 per share in net cash on the balance sheet, NOK trades at about 9x 2022 adjusted earnings per share. (That’s using the consensus estimate for the fourth quarter, which in turn is informed by the company’s guidance.)
9x earnings is a multiple that suggests a declining business. Yet, at least looking backward, that’s not the case. In 2020, Nokia posted an adjusted EPS of €0.25 ($1 = €0.9398). It’s tracking toward €0.42 this year.
Industry tailwinds are helping, certainly. The worldwide rollout of 5G (fifth-generation) wireless is driving demand for Nokia equipment. But Nokia is also taking share from rival Ericsson (ST:ERICb) and showing an ability to compete with China’s Huawei.
The 5G rollout isn’t coming to an immediate end. Market share gains can continue. Yet after a 26% year-to-date decline, the NOK stock price would suggest that profits — at best — are going to stagnate going forward.
Of course, earnings have stagnated in the past, even when Nokia could post some growth. That aside, there are concerns.
The first is that the 5G rollout is not permanent. It won’t end next year, but the cycle clearly is in Nokia’s favor. There’s an argument that the growth posted in 2021 and 2022 is cyclical rather than secular — which means that NOK stock should have a low multiple befitting a cyclical top.
Similarly, supply chain snarls hurt Nokia’s earnings in 2021, in particular. The situation is improving, allowing Nokia to book orders as revenue and potentially helping profit margins. As with the cyclical argument, the worry is that Nokia’s 2022 growth isn’t the sign of an inflection point in the business but rather the result of external factors.
To be fair, Nokia does have an offset to those tailwinds. Its Nokia Technologies unit, which manages the company’s patent portfolio and drove a significant share of 2021 profit, has disappointed in 2022.
Nokia is in litigation with two Chinese headset manufacturers while also looking to renegotiate the terms of current licenses; a resolution on that front could provide exceptionally high-margin revenue that can boost growth next year.
Finally, there are long-running free cash flow concerns. Nokia’s equipment business is capital-heavy, and valuation based on FCF is not nearly as attractive. At the midpoint of post-Q3 guidance, admittedly a wide range, Nokia trades at about 16x free cash flow, even excluding net cash. Using P/FCF instead of P/E, NOK looks much less attractive.
Considering the company’s history, these worries are probably enough to stay on the sidelines for now. Nokia remains a 'show me' story. But it’s also worth keeping an eye on, particularly coming out of fourth-quarter earnings.
If Nokia can deliver on its potential and give strong guidance for 2023, there’s the possibility of a big rally — and this time, a rally that can stick.
Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.
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