Tech Trader Daily: Nokia: Morgan Stanley Ups to Buy Awaiting Return of Apple Royalties

Following a Q4 report last week by Nokia (NOK) that featured unexpectedly high profit margin, Morgan Stanley's Francois Meunier today raises his rating on the stock to Overweight, and raises his price target on the ordinary shares to €5.70 from €5, writing that 2017 "could be a turning point for the shares." 

Nokia's ordinary shares today closed up 11 Euro cents, or 2.5% at €4.51, while the ADRs are up 12 cents, 2.5%, at $4.87. 

The stock is now cheap enough to take a bet, says Meunier, at 8.2 times as a multiple of enterprise value to Ebit, which is below a "normalised" 10 times. 

The margins are now showing strength, he notes: 

Buying Nokia because it is inexpensive did not work at all in 2016 as margin expectations were too high into a fast declining market and because of investors positioning. We believe that the weakness in the wireless market is well understood now, management has derisked the margin forecasts for 2017 at the CMD, and investor positioning seems to have reversed. On a more fundamental point, we admire the gross margin performance of Nokia in such a difficult environment - with sales down 10-15% all year, gross margins have remained good in the 39-42% range - closer to a European semiconductor company than to Ericsson. It proves, in our view, that customers prefer Nokia's products over Ericsson. 

Part of the collapse in profit has been the absence of royalty payments Nokia had been getting from Apple (AAPL). Meunier takes what he views as a conservative stance, assuming there's no Apple payments this year but that it comes back in 2018: 

Management was very clear on the call that Apple patents (€150m) should be taken off from the Technologies forecast for 2017. We had already corrected for that in our forecasts at the beginning of the year and we believe by the end of this week consensus should have adjusted. The swing factor is around the costs related to the Apple litigation. A positive outcome would be an early settlement. A negative outcome would be a long litigation leading to an increase in litigation cost in the tune of €100m. We sit in the middle with Apple paying nothing in 2017 and €200m in 2018 but of course assume a catch-up payment for 2017 that we factor in to cash flow. 

The stock's even cheaper, 7 times, if one considers those royalties, he argues: 

Telecom Equipment shares tend to trade on 10x EV/EBIT the current year but if we look at 2018 as more normalised earnings, with Apple paying €200m a year of royalties, and no profit from Submarine and RFS (we assume those businesses would have left the perimeter) then the shares trade on 7x, which is also inexpensive. 

He notes, too, that Nokia has done okay against Ericsson (ERIC) despite all the work Nokia had to do to integrate its purchase of Alcatel: "Interestingly, Nokia hasn't underperformed Ericsson through the integration process while Huawei has continued to benefit from a strong domestic market." 

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