Foreign Magic Formula Stock? Nokia (NOK)
Nokia is the biggest maker of mobile devices in the world, with nearly 40% global market share of the handset market, which dwarfs that of competitors Motorola (MOT), Samsung, and LG. The company is exceptionally strong internationally, with a #1 market share in nearly all markets it serves, and sells over 90% of units outside of the North American market. The Nokia Siemens Network Group contributes nearly 35% of revenues by supplying equipment and infrastructure to network providers to implement cellular standards such as GSM, and data standards such as EDGE and 3G protocols. The recent acquisition of GPS mapmaker NAVTEQ added about 2% of recent sales at operating margins exceeding 20%.
Nokia's growth will primarily come from new cell phone purchasers in emerging economies like China and India. The company's exceptional scale allows it to produce a commodity product (low-end cell phones) at much cheaper prices than it's competitors - a key advantage. Nokia's scale advantage here is so dominant that it allows the company to earn over 15% profit even on these entry-level units, while it's most profitable competitor, Samsung, earns slightly above 13%. As prices continue to drop, only the firms able to produce at low enough prices will remain viable, and Nokia is clearly in the driver's seat here.
The company is also trying to grow it's service offerings, expanding into music and games, and adding a big bet on location based services with the acquisition of NAVTEQ. In addition to earning incremental revenue from these services, it's also a good way to build brand loyalty (or, more to the point, customer lock-in), as users become accustomed to Nokia's services and opt to replace their existing phone with another Nokia model instead of jumping to a competitor.
Financially, Nokia is rock solid. The balance sheet has about EUR 5.5 billion against about EUR 4.4 billion in debt, about 70% of which are in short term notes (long-term debt is just EUR 860). Return on capital is very impressive. Since 2004, MFI ROIC is over 160%, amazing for a company of this size, and standard return on capital is equally impressive at 75%. Margins have been solid as well. Operating margin 5-year average is 13%, free cash flow margin 9%. Nokia also pays a solid dividend yield of close to 4% at current prices. The dividend was cut about 20% in January, but payout ratio with the new rate is in pretty safe territory.
Those margins and return on capital figures are a testament to Nokia's competitive moat. Most of this we covered earlier, as Nokia's economies of scale and dominant market share allow it to be the low cost producer in a commodity market. However, there is some question as to the durability of this moat. The cost advantage applies to purchasers of low-cost models, mainly in emerging markets, but it does not apply to the cell phone market that is emerging in the more developed economies of North America and Europe. Which brings us to the biggest risk...
Nokia is clearly facing some serious and effective competition in the high-end "smartphone" category, the fastest growing sub-sector of the market. While Nokia is still the world's biggest smartphone maker, competitors Apple (AAPL) with the iPhone and Research in Motion (RIMM) with the Blackberry have quickly gained market share and are now threatening Nokia in foreign markets as well. Nokia's software solution was to fully acquire Symbian and open-source it, hopefully allowing a development community to fashion a smartphone operating system for them. This plan is risky, as Symbian is not inherently a smartphone OS like Apple's or RIM's. Smartphones are a very important niche to watch, as they clearly represent the future of mobile devices and provide significant lock-in potential for both consumers and developers. If Nokia falls behind here, it will be very difficult to catch up.
Nokia's current earnings yield is about 12.6% (about a 10 EV/E), quite cheap for such high margins, return on capital, and dividend yield. There are no serious competitors in the low-end market, and it's unlikely any new competitors will emerge here to challenge Nokia's dominance. Moreover, there should always be a market for people who want "just a phone!". Also, the network equipment group is in good position to benefit from constant upgrades to boost data transfer speeds (EDGE to 3G to 4G and beyond). This makes Nokia look like a good buy at current prices. However, it would certainly not be a Top Buy consideration due to a poor longer term outlook that will likely put a low ceiling on the earnings multiple.
Disclosure: Steve owns AAPL
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