Even as Nokia Corporation (NYSE:NOK) remains bullish on opportunities in the 5G market, NOK stock has declined by almost 38% in the last 12 months, compared with a 7.5% gain for the S&P 500 index.
With news on Nokia replacing Chief Executive Officer Rajeev Suri, the reason for NOK stock under-performance is clear. In the race for 5G networks, Nokia has fallen behind Huawei Technologies and Ericsson (NASDAQ:ERIC).
However, as the markets are still at this early stage of 5G rollout, it’s far from over for Nokia. On the CEO change, Inderes analyst Mikael Rautanen opines that “Nokia needs a bigger change, and that starts from the renewal of management.”
I also believe that as the company focuses on regaining lost ground, NOK stock is attractive after a deep correction. While fiscal year 2020 is likely to remain challenging, Nokia shares are worth accumulating for upside in the next 18-24 months.
Margin Pressure Will Remain
There are several potential positives to talk about for FY2020 and FY2021. However, I would first like to address the concerns.
I believe that margins for Nokia Corporation will remain under pressure through FY2020. The reasons are as follows:
- Competition is already intense and companies are looking at gaining market share through initial 5G contracts. This will translate into pressure on EBITDA margins.
- Nokia is planning to accelerate its product roadmap in FY2020 through additional 5G investments. While the focus is on driving product cost reductions, it’s likely that FY2020 margins will be hurt due to high investments.
- Nokia has mentioned in their Q4 2019 commentary that there is “potential for a temporary disruption, particularly in our supply chain, due to the coronavirus outbreak.” If this holds true, margins will be squeezed.
Looking Beyond 2020 Challenges
Nokia might be lagging competitors in the 5G race, but there are silver-linings. I see the following positive factors:
- Nokia seems to have made a decision on China, which was necessary. The company’s entry and profitability potential in China’s 5G race was always in doubt. Nokia did mention in their conference call that “we are not backing away from China.” However, it’s clear that the company will only pursue contracts that are profitable. From the overall margin perspective, this seems like a good decision.
- The “5G Powered by ReefShark” was 10% of the company’s 5G product shipment in Q4 2019. By the end of FY2020, ReefShark shipment will increase to 35% and further to 70% by the end of FY2021. Besides performance advantage, the product will deliver higher margins. This is the reason to expect expansion in EBITDA margin in FY2021.
- Nokia Technologies manages and licenses the company’s patent portfolio. The company has more than 150 licensees that include all major smartphone vendors. One of the strategic priorities of the company is to expand the patent portfolio, which should translate into sustained cash flows. I am bullish on growth for Nokia Technologies in the coming years with the company’s investment in research and development.
- Nokia might be lagging behind Huawei and Ericsson. However, the company already has 66 commercial 5G deals and 19 live networks. In addition, the company has more than 100 5G agreements. As deals continue to flow, I expect NOK stock to react positively.
Concluding Views on NOK Stock
It’s clear to me that NOK stock has discounted the margin concerns for FY2020. The coronavirus impact on the supply chain remains uncertain. However, the stock is already depressed and unlikely to see any major correction.
Other than the positives discussed, the company’s free cash flow is likely to remain positive in FY2020. As the cash buffer grows, Nokia Corporation might be positioned to renew dividends in the next 18-24 months.
With Lundmark now leading the Nokia charge, the markets will also focus on the new CEO’s vision and roadmap. It remains to be seen if the he can help in accelerating the company’s 5G growth.
Overall, NOK stock is attractive for gradual accumulation as I see limited downside risk from current levels.
Faisal Humayun is senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.