Nortel Dips into Penny Stock Territory

National Bank analyst Kris Thompson has dropped the hammer on Nortel (NT); reducing his target price to 50 cents from $2.75, while downgrading his recommendation to “underperform” from “sector perform”. Here are some excerpts from his report:

In our view, Nortel’s financial position is set to weaken materially in the face of a strong USD, a global sell-off in stock markets (impacting its pension plan assets) and evidence that competitors are gaining relative traction. Nortel may need to implement a restructuring plan larger than we had anticipated.

Our DCF-based $0.50 target price equates to a 5.3x EV/EBITDA multiple on our 2009 estimates. Our initial thesis was to reduce holdings on positive news events (e.g., sale of Metro Ethernet business, China Telecom CDMA win). Given the unprecedented change in the economic outlook we’d exit any remaining investments in Nortel and seek companies with strong balance sheets and positive cash flow.”

In terms of financial projections, Thompson is looking for a year-over-year decline in revenue of 4.2% in 2008 and 5.3% in 2009. While he’s still expecting EBITDA margin expansion next year, the reduced forecasts are based on “an expected lag of cost cutting compared with revenue deceleration.

He believes Nortel could take a $360-million restructuring charge in the fourth-quarter to account for headcount reductions, facility closures and additional restructuring.

With Nortel poised to unveil its third-quarter results within the next couple of weeks, UBS Securities analyst Nikos Theodosopoulos has downgraded the stock to “neutral” from “buy” based on lower expectations about the company’s profitability and liquidity due to slower spending by customers.

He expects Nortel’s cash to decline to $1.3-billion by 2010. At the end of the second-quarter, Nortel had $3-billion in cash.

Less than a month ago, Theodosopoulos upgraded Nortel to a “buy” for the first time in more than four years based on the idea that the sale of the metro Ethernet network business could lead to the sale of the entire company or a break up that would leave Nortel as an enterprise-focused player.

At the time, Theodosopoulos has a target price of US$3.25. In mid-September, he dropped his target price to $6 from $7.50.

Reuters has some more information from Theodosopoulos’ reports, including these quotes:

We are increasingly concerned about Nortel’s liquidity given deteriorating conditions,” UBS analyst Nikos Theodosopoulos wrote in a note to clients.

We would expect Nortel to get more aggressive with its restructuring efforts in order to prop the business model, particularly as the environment toughens.

The company will most likely also have to contend with cash restructuring charges, including severance, limiting the total benefit.

Even more: Somehow, I missed that Nikos reduced his target price to $1.30 from $3.25.

Nortel closed yesterday at 99 cents after hitting a low of 96 cents. Its market capitalization is now $491-million.