Nokia (NYSE:NOK) stock is, as many have speculated, on a path toward reasserting itself as a well-regarded name in tech, mobile networks, infrastructure, and cloud services. The fate of the company’s resurgence will be determined by its performance in the 5G arena.
The shares have been relatively strong since Nokia announced strong earnings results in late April. The Finnish company’s results make NOK stock a worthwhile investment, as the firm’s recent success looks like the beginning of a longer-term turnaround. However, there is one question about Nokia that shrewd investors should consider moving forward.
Nokia is in the Midst of a Turnaround
The tech company managed to increase its net sales by a modest 3% in Q1 versus the same period a year earlier. This figure was a significantly higher 9%, excluding currency fluctuations.
The important aspect of the Q1 results, however, was that Nokia generated a profit after suffering a loss in Q1 of 2020. Its Q1 operating profit came in at 431 million EUR, versus a 76 million EUR operating loss in the same period a year earlier.
The reversal can be attributed in large part to the leadership of Pekka Lundmark, who became Nokia’s CEO in March 2020.
Nokia has trimmed its expenses, increased its operating margins and, as a consequence, has become profitable, as its Q1 bottom line came in at 263 million EUR.
Nokia’s leadership is remaining conservative in some respects. The company reported a 15.3% return on invested capital in Q1 of this year, up 3.8 percentage points YOY.
Nokia expects its 2021 ROIC to be between 10% and 15%, even though the figure came in at 15.3% in Q1. However, it says that it only expects its ROIC to be between 15% and 20% in 2023. As a result, I think its 2021 ROIC guidance may have been intentionally conservative.
A Problematic Business
Although Nokia is headed in the right direction, as shown by its Q1 results, it still has some worrisome issues.
One of the company’s main problems involves its Mobile Networks business. The extent to which the unit can compete with its peers is still unclear. Indeed, the company stated: “Competitive intensity, which is particularly impacting Mobile Networks and is expected to continue at a high level in full year 2021, as some competitors seek to take share in the early stages of 5G.”
The Q1 performance of the Mobile Network (page 9) was mixed. Its sales fell 4%, YOY to 2.26 billion EUR. So it appears that competition did hurt the unit. However, the unit’s operational efficiency did improve last quarter, enabling it to report a profit in Q1, versus a loss during the same period a year earlier.
Mobile Networks is one of the major pillars of Nokia’s business. The unit relies on Nokia’s 5G ReefShark chip, which accounted for 44% of its shipments in Q1. The chip is what is known as a System on Chip (SOC) component. It is essentially a computer on a chip.
The ReefShark SOC, which Nokia uses for its 5G equipment, is superior in many ways to the previous chip that it used. But the decline in Mobile Network’s revenue does not bode well for Nokia’s 5G hopes.
Nokia’s Network Infrastructure business, by contrast, was strong across the board, as the sales of each of its four network infrastructure types – IP, Optical, Fixed, and Submarine – all increased. Overall, the unit’s sales rose 22% YOY.
So while Nokia’s Network Infrastructure business was very strong, its Mobile Network business was weaker in Q1 than a year earlier. Those two businesses together account for 79% of Nokia’s revenues. The fact that the sales of the larger unit decreased will raise some eyebrows moving forward.
I think NOK stock is worth buying right now, as the company has become more efficient and profitable. However, Nokia has to prove that its Mobile Networks unit can compete with its peers or investors will continue to hesitate to buy NOK stock. After all, 5G is the primary reason investors care about Nokia, even though its shares remain inexpensive.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.