Nokia's (NOK) results for Q1 2013 are a messy mixture of maddening and pleasing. When I look through the report, I am torn between patting myself on the back for being so wise in investing in this company and remonstrating myself for believing that this company has a bright future. I am sure that many NOK shareholders and Seeking Alpha readers feel exactly the same way.
To begin with, the single most glaring negative indicator was Nokia's rather drastic decline in total mobile phone volume, both sequentially (-25% QoQ) and yearly (-28% YoY). This negativity was not covered up by its supposedly under-rated HERE division, which recorded a 22% decline in sales YoY yet nevertheless managed to lose even more money (EUR -97m Q1 2013 compared with EUR -94m in Q1 2012. NSN, its joint venture with Siemens recorded an operating profit of EUR 3m, rather less than what one would hope for on sales of EUR 2.8 billion. Overall, Nokia's net sales were down globally 20% YoY indicating continued problems of selling its actual goods and services in every division, sector and geographical area.
There were some interesting positives. However, I am deeply torn between whether these are positives or just isolated contrarian indicators in a sea of decline. Lumia smartphones sales increased from 4.4 million last quarter to 5.6 million this quarter. This 27% increase is even more impressive than it sounds. Historically, Nokia records Q1 declines after the holiday season. One would expect a decline of 25%. For evidence of this industry trend, look for iPhone (AAPL) sales decline next week in the Apple quarterly report. Breaking this trend therefore, netted Nokia about 70% more Lumia sales than one would expect. Even more impressively, Nokia forecasts sequential growth even better for Q2 2013 indicating it expects in excess of 7m Lumia sales. Adding icing to the cake, smartphone ASP increased (from EUR 143 in Q1 2012 to EUR 191 in Q1 2013), as did gross margins. One can therefore say that this particular aspect of Nokia, its most high profile, is on a definitive upward trend.
Now taking the report in its entirety, one can predict both positive and negative articles in the following days and weeks populating the web. Daniel Kahneman, the Economics Nobel prize winner (2002) writes of something known as "confirmation bias." Effectively what this means is that once an opinion is formed, we are prone to selectively interpret information which fits our preconceived notions. This is especially so in the stock market where we all have sunk costs (i.e. we are either holders or shorters of NOK stock). We will see much evidence of this in the coming weeks. What this should mean for the discerning investor is to beware of your initial instincts regarding this stock, there is going to be continued volatility in this stock for a great deal while longer. There are so many divergent indicators, that it is practically impossible to form a coherent narrative regarding Nokia.
My personal thoughts are these. Back in February, I wrote an article stating I believed that Nokia's feature phone sales were in irreversible decline. I predicted sales would be in the low-60 millions. In fact they were only 55.8 million. I believe that Nokia is engaged in an under-reported battle to replace its feature phone sales with the Asha line. I thought that whilst the media may not notice this battle, Nokia strategists were well aware. Now, looking at a rather dramatic drop in Asha sales from 9.3 million last quarter to 5 million this quarter, one has to wonder if Nokia truly realizes the scope of this problem. I would have hoped that sales would have risen sequentially alongside the Lumia line. I truly wonder if Nokia realizes that it cannot fight long term in the feature phone market.
In any industry, the idea of a European manufacturer successfully competing in the volume sector against Asian manufacturers is risible. This is not due to some cultural difference but based on the systemic weaknesses multinationals face. Multinationals must follow the rule of law, they must obey patent regulations, pay taxes, pay their workers officially, use invoices for all goods and services procured etc. Most of all, they receive no explicit or hidden subsidies. Technological goods are now regarded as strategic industries by many emerging countries and they will do whatever it takes to develop their indigenous manufacturers.
Nokia needs to recognize this is a battle that it cannot win. It needs to stop competing on volume, move up the value chain and focus heavily on its Asha and Lumia line. I see evidence of this with the Lumia, but if it does not want to be eviscerated from an unexpected angle by having negligible feature phone sales in the coming quarters, it needs to invest more in its Asha line.
This brings to mind Nokia's new Vietnamese plant. Unfortunately, I strongly suspect this plant is focused on feature phones. Now, I do not know the state of capital equipment Nokia has at its disposal, but I would like to see more focus on developing its manufacturing capacity (and lowering costs) on its Asha and Lumia line. This will prevent the supply constraints Nokia has continually faced, especially with the Lumia which has cost it real money in lost sales. A factory better aligned with demand would allow Nokia to conduct global Lumia launches instead of being forced into staggered launches on single carriers.
In the coming quarter, I provisionally predict continued weakness in its feature phone sales offset by rising smartphone sales. One can easily see NSN continuing to improve its operating margin. I can also see HERE continuing to be an interesting repository of shareholder value. It won't add to Nokia's profits, it won't cause it significant losses, but it will represent a sizeable amount of value through its IP and serve as a proxy by which to introduce other Nokia products and services.
I would ask all Seeking Alpha readers to put outside their own biases, long or short and look again at Nokia's report and ask if this is a company in decline or if there is scope for growth. Personally, I can understand if some investors now choose to look elsewhere. I will stay Long NOK, but only because I only choose to invest in companies (and sectors) I thoroughly understand. I appreciate NOK is a risky endeavor, but I still believe it's a growth story somewhere, hidden under the red ink, I just won't be patting myself on the back, there have been better success stories in the last 6 months.