Nokia (NYSE:NOK) has been an underperformer in the last year even as the company is bullish on 5G driven growth. I do believe that Nokia has a significant addressable market and that there are reasons to be positive on long-term growth. However, Nokia stock is unlikely to see any major up-move in the coming quarters.
There are three primary factors likely to keep NOK subdued through 2020:
First, Nokia has stated that it is facing “profitability challenges” in China. With intense competition with the likes of Ericsson and Huawei, “it could take years for the agreements to reach profitability.” China is a big market in the long-term and Nokia faces a big dilemma on Chinese contracts.
Second, Nokia announced in January 2020 that it has reached 63 commercial 5G deals. The number of deals has been increasing, but has failed to trigger positive stock reaction. A key reason is attractive pricing offered in early 5G deals to make inroads in the market. Therefore, it’s not just China where Nokia faces profitability challenge. Margins, in general, can remain under pressure in the initial years.
Third, Nokia intends to accelerate investment related to 5G. The company will invest in “System on Chip based 5G hardware.” In addition, investments relate to creating cost competitiveness. As R&D expenses accelerate, margin pressure will intensify.
Overall, costs will remain high through 2020. As the bottom-line and cash flow remains depressed, I don’t see NOK moving higher.
Several Positive Long-Term Triggers
Nokia does face challenges in 2020 and potentially in 2021 related to the high costs that would affect its cash flow. However, the company is positioning itself to benefit from 5G and the internet of things in the long-term.
In December 2019, Nokia signed a contract with TIM to provide IoT services to enterprise customers in Brazil. Nokia and AT&T (NYSE:T) also have launched an IoT innovation studio in Germany with a focus on innovation and tacking global business problems.
The global IoT market was valued at $190 billion in 2018 and is expected to reach $1.10 trillion by 2026. This implies an immense potential for growth and Nokia stands to benefit.
In the 5G market, Nokia phones can also trigger top-line growth. I’m bullish on Nokia 5G phones with the company focused on affordable 5G. The phone will be launched in 2020 at a price that is likely to be half of the current 5G phone prices. This phone can find takers in emerging markets like China and India, among others.
Another cash flow growth trigger is the company’s licensing revenue, which is reported under “Nokia Technologies” segment. For the third quarter of 2019, Nokia reported a licensing revenue of 358 million euros, which was higher by 2% on a year-on-year basis. Importantly, the segment operating margin was 82.10%.
In 2018, Nokia had pegged the value of 5G patents at $3.50 per smartphone. This would translate into a meaningful cash flow bump-up once 5G phone adoption gains traction globally.
My Final Thoughts on Nokia Stock
Nokia is likely to focus on gaining market share in 5G and accelerating R&D efforts in the next 12-24 months. This period is likely to be associated with pressure on margins and weak cash flows. This can keep NOK stock relatively depressed.
However, there is a big addressable market related to 5G, internet of things, cloud service and artificial intelligence. Nokia is positioned to gain from inroads in these segments in the coming years. Further, licensing revenue growth can boost margins.
Overall, with margin concerns and dividend suspension, Nokia stock is worth avoiding. While there may be trading opportunities, investors can wait before long-term exposure is considered.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.