Since the beginning of November, shares of Nokia (NYSE:NOK) have remained in a very tight range. This sideways move comes after a decline of 38% for the stock in the last 12 months. Even at $3.60 and a market capitalization of $20 billion, I remain bearish on the name for the coming year. As reader might expect, there are several factors for this bearish outlook.
The first reason to maintain a bearish view on the telecoms maker is the earnings outlook for 2019 and 2020. For 2019, Nokia expects non-IFRS diluted earnings per share of 0.21 EUR (23 cents). For 2020, Nokia expects non-IFRS diluted EPS of 0.25 EUR.
Importantly, the earnings guidance has been revised on the downside for both years when the company released Q3 2019 results. This didn’t please the markets and sentiments will not change unless there is an upward revision to the guidance. Sideways movement might be markets way of telling that the stock is fairly valued based on current earnings expectations.
Cost Pressure to Will Cost Nokia
I believe that for the remainder of 2019 and through 2020, cost pressure will temper the stock’s upside potential.
For the third quarter of 2019, Nokia reported R&D expenses that were 18.6% of revenue. Further, SG&A expense was 13.0%. While expenses have declined in Q3 2019 as compared to Q3 2018, it still affects EBITDA margin in a big way.
Further, investment related to 5G, enterprise and software businesses will continue to hit margins in 2019 and 2020. It’s in 2021 that Nokia expects to improve its financial performance from a margin and cash flow perspective.
It is also worth noting that for the first nine months of 2019, Nokia reported cash used in operations of 1.2 billion EUR. With the additional investment requirements in 2019 and 2020, it is likely that operating cash flows will remain negative. This holds true for the next five quarters.
The management also expects improvement in “2021 financial performance relative to 2020.” Therefore, operating cash flows will be negative in 2020, but it does not imply that OCF turns positive in 2021.
Therefore, the markets will look at the timing when Nokia turns both OCF and free cash flow positive. I believe that there is no dividend visibility for the next 24-30 months.
To back my point on dividends — Nokia expects to resume dividends when its net cash position in 2.0 billion EUR. As of Q3 2019, the company’s net cash position was 241 million EUR. Clearly, it is long before dividends resume.
From a stock upside perspective, compressed margins through 2020 will not provide any cheer. The markets will look at 2021 guidance for any possible upside trigger.
5G Provides Hope Beyond 2020
One of the reasons for depressed margins in 2019 and 2020 is the increased investment in 5G. Nokia expects to deliver growth and cash flows beyond 2020 with 5G as one of the key drivers.
Most companies are looking at 2020 as the game-changing year for 5G revenue acceleration. As an example, Ericsson revised 2020 guidance up while Nokia remains bearish for 2020. Therefore, it does seem that Nokia is lagging peers like Ericsson (NASDAQ:ERIC)and Huawei.
However, the 5G opportunity is not limited to 2020, one country or few sectors. It is an opportunity that will reward well-positioned companies in the next decade. If Nokia is successful in accelerating top-line growth and margin expansion in 2021 and beyond, the stock will respond positively. As a matter of fact, Nokia already has 50 commercial deals for 5G.
I want to add here that the trade war can also have positive implications for Nokia. As the Financial Times reports, U.S. government officials have suggested issuing credit to companies such as Nokia and Ericsson to enable them to match the generous financing terms that Huawei offers to its customers.
Final Views on Nokia
Nokia disappointed investors with lower guidance for 2020. The stock slumped and has consolidated at lower levels. Even if top-line growth accelerates in 2020, margin compression and cash burn will keep the shares sideways.
The next key trigger for Nokia shares is likely to be a first guidance for 2021. If margin expansion does happen, the shares will move higher. As well, 5G still provides hope for Nokia even when the company is making slower progress.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
