Nokia Punished for Lack of High-End Smartphone

Finnish cell phone maker, Nokia Corp. (NOK) reported first quarter results on Thursday morning that clearly missed the mark as the stock opened 15% lower on extremely heavy volume early. The company reported net income of EUR349 million versus expectations of EUR370 million. In dollar terms and adjusting for one-time items, Nokia earned 19 cents per share which was just slightly below the consensus estimate of 20 cents. Revenue of approximately $12.82 billion did show growth of 3%, but they fell considerably short of expectations for about $13.42 billion. While both the top-line and bottom-line results were not as improved as hoped, perhaps more distressing were the details behind the results.

Nokia, which is the global market share leader for cell phones, lowered its average selling prices more than expected to defend that share from strong competition. Overall, the average selling price (ASP) fell 6% to $83.5 compared to $88.8 a year ago and $86.1 in the fourth quarter. However, the price cuts were even more extreme in the vital smartphone market as average prices of Nokia smartphone dropped 17% to just $208. Nokia had a higher sales mix of their cheaper models. The lower ASPs squeezed margins as gross margins fell 140 basis points to 32.4%, and operating margins shrunk from 12.5% to 8.9%. Also, the company lowered second quarter operating margin guidance for the phone division to 11-13%, as analysts’ had expected 13.7%.

Further casting doubt on the company’s future, they delayed the launch of the new version of its software, Symbian, from the second quarter to the third. The Symbian upgrade is regarded as a necessary component to creating a high-end smartphone that can compete with the iPhones, Blackberries, and Android phones already on the market. Nokia has lost market share in smartphones to it competition since its last widely adopted high-end smartphone, the N95 all the way back in 2006. Further delay puts Nokia even further behind in the land grab for prominence in the rapidly expanding high-end smartphone industry. Gartner research estimates that the global smartphone market will expand by 46% this year, and Nokia will have an uphill battle against more established products with already multiple refreshes and updates. To be clear, Nokia makes many smartphones and still commands a global market share lead, but most of these sell for a “low-end” price and development of a new, truly high-end device has been stagnant for years.

The good news is that, despite their weak first quarter, Nokia has reaffirmed their global market share estimate of 33%. Surely, Nokia has staked its claim as the dominant player in the cell phone market, and there is still huge sales potential in emerging markets for a simple cell phone. Nokia believes the overall cell phone market will grow by 10% this year. However, these products are increasingly commoditized and ASPs as well as margins will almost surely continue to trend lower. Smartphones are where the profits are (see Apple’s quarterly release) and in mature markets like the US and Europe their usage rapidly climbs each quarter.

At Ockham, we have an Overvalued rating on NOK as of this week’s report, as the stock’s price had advanced about 17% year-to-date coming into the report. The stock had clearly advanced strongly and we believe it had gotten ahead of fundamentals. Considering the weakness of first quarter results, we are unlikely to upgrade the stock based on valuation, despite the extent of declines today.

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