Can Nokia Turn Things Around?

Sep.14.12 | About: Nokia Corporation (NOK)

Every now and then, I take a look at a struggling company and ask if it can turn things around. I look at the company's current situation, financial picture, and recent news to see if this name could recover eventually, or if it will struggle more. Today, my focus turns to Nokia Corporation (NYSE:NOK), the Finnish communications company that is behind the Lumia phone.

On Thursday, Nokia's shares rallied nearly 7%, almost touching the $3 level for the first time in about three weeks. Thursday's close was the highest since the introduction of the Lumia 920 phone. Investors are wondering if this is a fool's rally, or a sign of things to come.

Let's figure out where this company is headed:

Everyone knows that Nokia is struggling currently. When the company announced Q2 results, revenues were down 24% year over year to €14.8 billion. The net loss increased to €1.41 billion from €369 million. However, both phone shipments and revenues were up from Q1 levels. It was a mixed report overall. Nokia's overall phone average selling price fell to $59, and the company warned sales and margins would remain under pressure in Q3.

So one thing I always look at is the company's margins, shown in the table below. These are for the first half of each year.

Obviously, the decline in gross margins was not good. Nokia lowered some of its phone prices in an effort to get more sales, and that is clearly seen. Gross margin dollars were down nearly 36%, compared to the 24% drop in revenues. When it comes to operating expenses, they were flat year over year. However, when your revenues decline by 24% and your operating margins don't change, it will crush your operating margins. That obviously happened, with operating margins falling 14.3 percentage points, despite gross margins declining by less than 5 percentage points. Bottom line numbers were almost as bad.

Analysts are expecting similar results in the second half of the year, with revenues falling about 29% in the third quarter and around 24% in the fourth quarter. For the full year, revenues are currently expected to decline by 24.3%. On an earnings per share front, the company is expected to swing from a $0.38 profit to a $0.40 loss (yes, those numbers are in US dollars). In 2013, analysts currently forecast revenues to decline again, but just by 2.6%. Earnings per share are expected to improve, but the current forecast does call for a small loss.

With the year-over-year drop in revenues and a much larger loss, Nokia's balance sheet did get a little worse over the past 12 months. The following table shows a few key metrics.

Nokia isn't in trouble yet, and had €4.2 billion in net cash at the end of Q2. However, MKM Partners is not impressed, and believes that cash could be gone in two years. MKM noted that cash could be burned from both operating losses, as well as the company's ongoing restructuring efforts. When Nokia reported, MKM reiterated its sell rating and $1.50 price target. They also noted that the entire value of the company was based on intangible assets.

So what are Nokia investors looking forward to? Well, the company recently unveiled the Nokia Lumia 920, the Windows 8 phone that supports wireless charging and features a 4.5 inch screen. Both Nokia and Microsoft (NASDAQ:MSFT) are betting big with Windows 8 here. However, the issue relates to timing. Microsoft is fighting to get the phones out on time, as Windows 8 is scheduled to be launched in late October. However, recent reports suggest that Windows Phone 8 isn't ready yet, and it might not be until sometime in November.

That could be an issue, as Apple (NASDAQ:AAPL) just announced the new iPhone, which will go on sale next week. The iPhone 5 is perhaps the most anticipated mobile phone in history, with some estimates calling for sales of up to 250 million units. Also, the iPhone will be out at least 5-6 weeks before the Lumia 920, meaning that Nokia will be playing catch up.

Deutsche is forecasting that Nokia will sell approximately 4 million Lumias in Q4 and 25 million in 2013. Apple will probably sell 4 million iPhones in the first couple of days, and should do well more than 25 million iPhone sales in Q4 alone. Nokia will have a hard time gaining market share, and Deutsche also is "worried Windows Phone 8's hardware requirements will prevent Nokia from profitably competing in the sub-$200 smartphone market, where Android has mostly wiped out Symbian, and is rapidly eating into Nokia's feature phone base."

Nokia currently reminds me of Research In Motion (RIMM). Both companies are trying to sell a small number of phones in an ever competitive space, and both are trying to slay the Apple dragon. If all goes well, Nokia should have some holiday selling season help, while RIM's BlackBerry 10 phones aren't expected out until January or February at the earliest.

Both Nokia and Research In Motion are seeing huge declines in revenues this year, and both are swinging from profits in their last fiscal year to losses in their current fiscal year. Both companies have balance sheets that are okay currently, but expected to get worse as they burn through cash during restructuring processes and phone launches. The two names have also seen their stock prices drop about 40% over the past six months.

Can Nokia turn things around? It is possible, but I'm leaning more towards no at this point. Revenues are falling this year and the decline is expected to continue again next year. The company may not be profitable until 2014 again. The Windows 8 phone launch needs to be perfect, and right now, that might not happen.

Any delays will be met with ultra negativity, just like RIM saw when it announced the BB10 phones were coming in 2013. Windows phones are having a hard time competing with both Android phones and Apple, and the iPhone will be out next week. Nokia's continuing losses and restructuring will continue to burn through cash for the next few quarters.

Analysts overall don't see a high probability of a turnaround either. The average analyst rating is a 3.3, which is a slight to moderate underperform rating. Of the 24 analysts currently with ratings on the name, 3 have buys, 13 have holds, 5 have underperforms, and 3 have sell ratings. The average price target (19 analysts) is $2.53, which is $0.41, or 14% below current levels. Nokia hasn't been able to gain much traction above $3 lately, and if we get any higher, it is going to be a prime short candidate again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.