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Company Description

Nokia Oyj (NYSE:NOK) (OTCPK:NOKBF) is a Finnish multinational telecommunications, information technology, and consumer electronics company. It operates across most of the globe and is one of the largest telecom equipment companies in the world.

Nokia has been in business for over 150 years, operating in all kinds of industries during this time, but is mainly famous for its former mobile phone business. At its peak, Nokia had a dominant market position.

The current iteration of Nokia has not been so strong. The business has struggled for the last decade, as it retreated from the mobile business while seeing other businesses stagnate.

Pekka Lundmark returned to Nokia after almost 2 decades as CEO. He proclaimed a “three-phase change in its (Nokia’s) business model,” which would return Nokia’s fortunes. This involved selling off low margins areas and focusing on the lucrative 5G space.

It currently operates 4 segments:

• Mobile Networks – Which provides services for Radio Access Networks (RAN), covering 2G to 5G. As well as, Microwave Radio Links (MWR).
• Network Infrastructure – Which provides network infrastructure to a wide range of customers, including, digital industries and governments.
• Cloud and Network Services – Which provides cloud and software solutions to assist clients in their network needs.
• Nokia Technologies – Which relates to Nokia’s current patent portfolio. This segment looks to monetize and expand Nokia’s intellectual property.

Investment Thesis

Recently, Nokia had its time in the limelight, becoming a Wall Street favorite and performing extremely well since Pekka Lundmark took over.

Nokia is currently trading at around €5, which is about the same as several years ago. Now, however, Nokia is in a much greater place, with genuine growth potential going forward with 5G technology.

Nokia looks set to be a market leader in this space, which is set to grow meteorically in the coming years. Nokia has already secured several contracts with leading businesses, while continuing to innovate.

Our belief is that Nokia can grow well during tough economic conditions. Where other businesses will struggle with falling demand and margin contraction, Nokia should continue with incremental improvements and more contracts won. Therefore, we think Nokia is a great investment for investors looking to navigate the next 24 months. We rate Nokia a buy.

Recent Update

Nokia and Kyndryl Holdings (KD) announced a partnership aimed at assisting clients with accelerating their digital developments, with reliable and secure 5G and LTE private wireless networking.

Nokia and Kyndryl are looking to provide support in transitioning to industry 4.0. This is the “adoption of computers and automation and enhance it with smart and autonomous systems fueled by data and machine learning.” One of the main problems the partnership looks to solve is geography. 5G coverage fails to cover remote locations used by large businesses and so presents an opportunity to provide private 5G services to ensure businesses remain at the forefront of technological advancement.

Kyndryl is a spin-off of IBM’s infrastructure services business, specializing in designing and building large information systems. While Nokia will bring the technology, Kyndryl will help with the bespoke fit, and sell to clients. Nokia’s 5G strategy is to secure private contracts with businesses as a means of expansion (rather than working with governments) and so partnering with a successful IT business with a good track record will inevitably help drive deals.

This has the potential to be significantly fruitful, as companies are looking to move into “industry 4.0.” Given the potential efficiency gains to be had through automation, most businesses will look to implement these technological changes. Importantly, no company will want to be the one that falls behind by not innovating.

Amazon has recently entered the market, launching a private 5G service within its highly regarded AWS.

This deal represents continued progress by Nokia in the 5G market. With the push for industry 4.0, there are greater economics to come from 5G operations, and so it is paramount Nokia focuses its efforts on securing clients.

Sector Analysis

Nokia estimates their total addressable market (“TAM”) to be €122BN as of 2022, with growth of 4%. This represents substantial growth potential, as Nokia currently has revenues of €22BN. Furthermore, Mobile Network excludes China. Should the Chinese government continue efforts to encourage Western companies within its borders, this could materially increase Nokia’s TAM.

Nokia’s estimated TAM (Q1 2022 Investor deck)

The global market for telecom network equipment grew by 7% year-on-year in 2021, the fourth consecutive year of growth. This underpins the strength in the market currently, as businesses and consumers embrace technological advancement. 5G is still in its infancy, and so our expectation is for this to remain robust going forward.

The current Telecom Equipment market by Revenue is as follows:

Telecom Equipment Market Share by Revenue (Dell’Oro Group)

What we note is that the 7 main players hold over 80% of the market, most of whom are larger than Nokia. We do not consider this concerning, however, as the ability to compete comes from the patents and strategy of the businesses.

One thing this chart does not reflect is the on-going effort of western governments (specifically the USA’s) to force Huawei out, due to security concerns. ZTE may also find itself in a similar situation. This represents a huge opportunity for incumbent firms, with double-digit business needing to be absorbed.

5G

In Nokia’s most recent broadband communication, Nokia stated that 5G had begun to pick up steam. It is predicted that it will contribute up to 1% of global GDP by 2030. 5G will be the most extensive telecommunications project to date, with a significantly larger proportion of the globe taking on the technology. This is due to the improvements in wealth across the world in recent years. It is estimated that 60% of the world’s population will have 5G by 2026, only 4 years from now.

When we look at Nokia, its technology is market leading. They have been innovating well and are looking to build a compelling offering. Recently, Nokia announced it had overcome challenges to having 5G in dense urban areas, with the potential to increase its FWA capacity by 5-10x.

This has allowed Nokia to secure a large number of contracts; currently, they have over 200 across the world. This includes BT (OTCPK:BTGOF) in the UK, AT&T (T) in the US, Softbank (OTCPK:SFTBY) in Japan, and Vodafone (VOD). Between these clients alone, Nokia has substantial coverage of broadband providers in the developed world.

Therefore, we are comfortable that the telecommunications industry still has much room to grow. Importantly, Nokia is well positioned to grow within this. The number of contracts signed to date gives us a level of assurance over revenue growth going forward, and the ability to secure more.

Economic Analysis

Economic conditions are clearly deteriorating. The U.S. has seen 12 months of >5% inflation and now negative GDP growth. This has led to fears of stagflation. Our view is that Nokia is positioned well to navigate these tough times. To be clear, the stock market is currently trending down, and I do not think Nokia will be immune to this, but performance shouldn’t be materially down. The reason for this is the nature of their service. Nokia is a crucial cog in the world’s infrastructure. Many of the investments made are implemented for the long-term, and so short-term blips are unlikely to cause them to end.

Therefore, although economic conditions will be tough, we are not concerned about the impact on the business. It will inevitably weigh Nokia down somewhat, but we do not believe revenue will fall greater than GDP.

Financial Analysis

Nokia has been on an EPS-beat role, and that continues into Q1 2022.

Nokia Earnings Performance (Yahoo Finance)

Sales were up 1% on a constant currency basis, importantly alongside a 250bps increase in gross profit margins. This suggests the inflationary pressures (so far) are not an issue for Nokia, and they have successfully passed these costs on to customers.

As for each specific department:

• Mobile Network – Margins have expanded an impressive 7.5%, this supports Pekka Lundmark’s vision to focus on margins strong business. Sales are slightly down as a result of supply chain constraints. Nokia believes growth will return in 2022, this seems quite conservative as we are already seeing evidence of backlogs easing in ISM’s reports. This said, China has recently re-entered strict lock downs in Shanghai and so this may be the source of Nokia’s hesitance to bring forward guidance.
• Network Infrastructure – Performance here has been nothing short of exceptional. Sales are up 9%, and operating margins 9.9%. As we have discussed, infrastructure spending is expected to remain robust.
• Cloud and Network Services – Once again, great numbers. 5% sales growth and 2.7% margins. Nokia has focused on operational improvements and we are seeing the fruits of this labor. It is clear, they still have a way to go in improving the efficiency of their operations.
• Nokia Technologies – Performance is down as a result of the expiration of agreements. Nokia do not say too much here beyond stating a desire to protect the value of their patents, and that they are confident in their strength. Performance has been flat since 2020, trending downwards, and so we would continue to monitor this further to ensure Nokia continues to innovate and remains at the forefront of technological advancements.

Nokia’s balance sheet is bulletproof and ready for anything to come. It currently has $9.5BN in cash, relative to long-term debt of $4.5BN. This is coupled with free cash flow positivity and double-digit operating margins. So, we see no concerns around liquidity and instead see this as a war chest which Nokia can deploy to continue its growth.

Guidance also looks strong. Analysts are expecting 5.8% top-line growth, with 7.7% growth in EBITDA. FCF will be down as a result of R&D investments. Considering the growth hopes we have for Nokia, we are glad to see sizable R&D spending again.

For these reasons, we think Nokia’s financial position is fantastic. They are conservatively financed and growing well. Operational overhauls are yet to complete, and so continued margin expansion is within the realms of possibility. Our only concern would be the health of Nokia Technologies.

Peer Comparison

Nokia only has one true peer, its Nordic Brother, Ericsson. We have highlighted key metrics below:

Nokia and Ericsson Compared (Tikr Terminal)

As we can see, Nokia is outclassed in every metric. Given the disruptive nature of the 5G market, forward-looking data is more important, and Nokia loses out here too. Ericsson has generally been the better business, but has historically commanded a premium to reflect this.

It is difficult to compare the valuation relative to performance as Ericsson has recently admitted to potentially engaging in business with ISIL, the terrorist group. This has hit the share price and will materially depress the price until Ericsson’s punishment is decided. As a result, Ericsson is currently a difficult investment proposition given this uncertainty.

Valuation

In order to value Nokia, we have conducted a DCF valuation. Our key assumptions are a reasonable 8.5x exit multiple (below Nokia’s historic average), a discount rate of 6.1% and steady cash flow growth.

Valuation Calculation (Author’s own calculation (Tikr Terminal))

This gives us a valuation in the region of €5.91- €7.38, which is an upside of 25%-55%. This is a substantial upside potential for an established business, reflecting the growth potential of 5G.

Final Thoughts

Nokia is a boring investment. It will not grow in the high double-digits, its share price will not explode and it will not become a mainstream brand again. However, if an investor is looking for an investment to weather the storm that is brewing, look no further than Nokia. Pekka Lundmark is a fantastic CEO who is revitalizing and improving all of Nokia’s key businesses. Alongside this, the 5G business is set to drive growth in the coming years. Our price target suggests a comfortable upside. We thus rate Nokia a buy.

Source: https://seekingalpha.com/article/4512539-nokia-this-risen-phoenix-should-be-in-all-portfolios