S&P revises Nokia’s outlook to negative on weak cash flow prospects

FRANKFURT: S&P Global Ratings revised telecom network equipment vendor Nokia outlook to negative on weaker cash flow prospects, and affirmed the rating at ‘BB+’.

“Nokia needs to step up investments in its 5G products during a critical stage when market demand is ramping up,” S&P noted.

The negative outlook reflects the possibility of a one-notch downgrade in the next 12-18 months if challenges with Nokia’s mobile access product portfolio and greater competition in this segment jeopardize improvements in EBITDA margins and cash flow, preventing FOCF to rebound.

Nokia lowered its guidance for operating margins and free cash flow in 2019 and 2020 after a year-on-year decline in gross margins in its Networks segment by about 500 basis points to about 29%. This mainly reflects higher product costs and the need for additional investments in its 5G mobile access product portfolio.

S&P forecast adjusted EBITDA margins of 8%-10% in 2019 and 10%-12% in 2020 compared with previous forecast of 10%-12% in 2019 and 13%-16% in 2020.

Nokia sees the need to scale up its investments in so-called “system on a chip” technology for its 5G base station products, the first generation of which so far relies on field-programmable gate array (FPGA) chipsets.

Although FPGA is more flexible and supports a wider range of applications, the technology is more expensive and has other disadvantages, such as higher power consumption, which remains an important feature for telecom operators deploying 5G. This issue increases the risk that the company may cede market share to competitors during a period when key markets such the U.S. and several countries in the Asia-Pacific region are stepping up their roll-out of 5G networks, especially since the product improvements will take time and continue throughout 2020.

“We think this could constrain Nokia’s growth prospects or profitability during the initial stage of 5G roll-out. According to market research firm Dell’Oro, Nokia was the number three player in the radio access network market in 2018 with a share of about 23%, after Ericsson’s about 29% and Huawei’s roughly 31%”.

“We could lower the rating if Nokia fails to show steady improvements in its FOCF, with moderately positive adjusted FOCF in 2020 and a path that leads to more than €500 million adjusted FOCF annually from 2021, equivalent to our adjusted FOCF-to-debt ratio of over 15%. We could also lower the rating if adjusted debt to EBITDA remains above 1.5x, with funds from operations (FFO) to debt below 60%. We think this could result from a combination of increased competition and setbacks in addressing the challenges of its mobile access product portfolio, compounded by sluggish performance in other segments and higher-than-expected restructuring costs”.

“We could revise the outlook to stable if Nokia successfully adapts its mobile access product portfolio while avoiding an erosion of market share and continues to show constant-currency revenue growth and improving profitability. This would support adjusted FOCF to debt of more than 15% and adjusted debt to EBITDA well below 1.5x”.

Edited by Nayyar Iqbal

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