Morgan Stanley’s Francois Meunier today reiterates an Underweight rating on shares of Nokia (NOK), while raising his price target on the ordinary shares traded in Helsinki (NOK1V) to �2.60 from �1.50, writing that the “news flow” for the company’s Lumia line of phones running Microsoft‘s (MSFT) Windows Phone 8 has improved, but that he worries about profits in the handset division and the Nokia-Siemens Networks equipment division.
The shares are�up 14 cents, or 3.2%, at $4.57, helped in part, no doubt, by a report this morning from market research firm�Kantar WorldPanel�stating that Windows Phone saw “strong European growth” in the twelve weeks through December 23rd, �claiming 5.9% of sales in Britain and 13.9% in Italy, way up from year-ago levels. The ordinary shares today are up 1.4% at �3.42.
Meunier’s new target reflects a “going concern” take-out value for the business, rather than the “break-up value” he had previously been using. On that score, he writes, there are “Two key questions,” namely, “How material will the turn around in the handset business be to long-term prospects?” and “What is the likelihood of a f further deterioration in cash, particularly driven by NSN?”
You can’t ignore the change in “sentiment” based on Lumia, writes Meunier, but he thinks even with a meaningful rebound in smartphone volume, Nokia needs more change to improve its handset prospects:
Smartphone revenues have started to grow again, as Lumia volumes have ramped and the decline of Symbian has become less material (see Exhibit 4). The key question is whether smartphone revenue growth can offset the decline in feature phones. Higher ASPs in smartphones mean it does not need a like-for-like market share gain to offset the decline in revenue terms. We expect Nokia to gain ~5% of global smartphones, growing smartphone volumes at 25% in 2013e and 30% in 2014. We expect net revenue growth of ~3-4% pa in Devices & Services over 2013-14, as Nokia feature phone volumes decline ~15% pa. Given competition in Windows Phone, we think upside beyond this depends on a more thorough revisit on product strategy, possibly involving the launch of an Android phone [�] We would be cautious before extrapolating stronger Q4 profitability to 2013/14: Q4 volumes are seasonally strong, pricing has been supported by new products, and write-downs of Windows 7 devices in previous quarters may have helped margins. We now assume smartphone gross margins recovering towards 16% by year-end 2013 � lower than feature phone gross margins at 22-23%. Q1 margin guidance in Devices is -2%, +/-4pp, which likely incorporates some more weakness on gross margins for smart devices.
He still sees it tough going for Nokia when the top two smartphone players,�Apple�(AAPL) and�Samsung Electronics�(005930KS) gobble up all the profit, as he illustrates in the following chart:
As for the Networks business, it’s the bright spot, but Meunier thinks the business may be reaching the end of a streak of better-than-expected profit, and he opines the business is still “sub-scale” in terms of being able to compete for equipment contracts, in contrast to Ericsson (ERIC), his preferred pick:
NSN is the primary driver of upside to our price target. We now assume a long-term margin of 5%, justifying an EV/Sales multiple of 0.5x and a valuation of �0.8 per share. As importantly, our base case is that NSN remains a financially independent entity, so no further cash contribution from Nokia Group is required to restructure, and we add a Group net cash balance of �0.6 per share back to our SOP valuation. Recent unconfirmed newsflow suggesting that NSN is in talks to raise a bond, which would presumably be used to refinance the term loan maturing in June, would imply a more independent financial future for the company.�While Q1 guidance implies NSN is reaching the tail end of recent supernormal profitability, cash generation has been much better than anticipated in 2012. Rationalising the contract base has also contributed positively to earnings.
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