Nokia (NYSE:NOK) deserves a look at current price levels. The stock bottomed in November, and I believe that it has the potential to be a good long-term pick. In my opinion, we will not see Nokia go down to around $4 again. Although the core business remains under pressure, cost efficiencies and synergies will provide support to margins going forward. Plus, the licensing fees from Nokia handsets, growing software business and possible royalty payments from Apple (NASDAQ:AAPL) might cause it to gain further momentum in the next few months.
There is no denying that the networking equipment industry is under pressure. The 4G market has slowed, and there is still time for the roll-out of 5G technology. As a result, the industry will remain under pressure in the next 2-3 years. It is all about saving costs in order to maintain margins. While Nokia has been able to achieve some cost efficiencies and synergies from the Alcatel-Lucent acquisition, overall margin deterioration is still evident. However, Nokia is yet to realize full synergies from the Alcatel-Lucent acquisition, and further cost-saving measures are also underway, so we should see some improvement in margins despite the weakness in the industry. The acquisition has started to pay off in terms of revenue growth as Alcatel-Lucent's Submarine Networks achieved strong growth, which resulted in full-year segment revenue growth of 34%.
A comparison with other industry players shows that almost all the players are having a tough time dealing with the declining growth in sales.
Calculations performed by the author. Data sourced from SEC filings (Nokia and Ericsson data converted to Dollars)
Nokia's gross margin has come down to around 36% in the last year, down from around 44% in 2015. Falling sales and a stronger dollar has resulted in lower gross margin for the company. On the cost savings front, the company has achieved better-than-expected results in almost all the areas. In cost of sales alone, Nokia saved around $213 million. Savings in the operating expenses were also around $107 million, more than the target. However, 2017 cost savings are going to be lower than the last year, but the company remains on course to save around $1.28 billion in costs by the end of 2018. In comparison, Ericsson (NASDAQ:ERIC) is certainly feeling the heat as the company has lost substantial sales, and its gross margin is now below 30%. Ericsson has the lowest gross margin out of the four companies compared here. Cisco (NASDAQ:CSCO) and Juniper (NYSE:JNPR) have the strongest gross margins. Both these companies have been able to maintain gross margins over 60% in the last four years.
Nokia's operating margin has fallen to -4.66% as the company reported an operating loss of more than $1.15 billion. Ericsson also has the OP margin in low single digits (2.6%) now. Both Nokia and Ericsson had operating margin of 13.5% and 8.8% in 2015. Cisco and Juniper continue to beat the European manufacturers with OP margin of more than 25% for Cisco and over 18% for Juniper. The trend continues for the net margin as well. The last section of the table includes debt, cash, EBITDA and leverage ratios. These companies have extremely strong leverage positions. Cisco, Ericsson and Juniper have total leverage ratios (Total debt/EBITDA) below 2x. Nokia's 2016 leverage ratio has gone close 8x due to a substantial decrease in EBITDA. However, the cash position is strong and net debt is negative, meaning cash at hand is more than debt obligations. So there is no threat from the leverage position. Net debt to EBITDA ratio is negative for all but Juniper. Net debt for Juniper has become positive, but it still remains extremely low. Finally, the EBITDA margin. Nokia and Ericsson's EBITDA margin has come down to single digits while Cisco remains the most profitable with an EBITDA margin of around 32%. The analysis shows that while the profitability has come under pressure for these companies, the financial position remains strong. Nokia is working to control the slide in its margins. These efforts should slow the decline in margins until the networking industry starts to grow again.
Nokia's Comptel acquisition should enhance its software business. The company is looking to pay around $370 million to acquire Comptel. This deal shows that Nokia does not want to just sit and collect royalty payments from the patents business. It wants to grow its software business. Software solutions has the potential to grow considerably. It is also a bit of move away from Nokia's core business of providing hardware for the telecom companies. Comptel provides services to operators in 90 countries. It will bring a large customer base to Nokia. Additionally, the combination of Nokia and Comptel technology will give it a better chance to further grow the business and increase penetration. The price has a premium of around 29%, and major shareholders with around 48% of the total holding have accepted the tender offer. The deal is likely to go ahead.
Patent fights with Apple again have the potential to bring in some royalty payments. However, it is unlikely that these payments will come in 2017, according to Morgan Stanley analysts. If this lawsuit goes in favor on Nokia, then the additional income from patents segment will further support the margins. Nokia handsets have been received well in China. HMD has clarified that the handset is not on flash sale. If these handsets continue to show strong sales, then the licensing fees from handsets will also be a positive for the company.
These developments and Nokia's efforts to control costs have the potential to push the stock price to around $5.5 in the next few months. Longer-term, networking equipment business should also return to growth. In the meantime, software and submarine networks business will continue to grow. Nokia is looking in a better shape and has the potential to be a good long-term pick.
Disclosure: I/we 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.