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Nokia Gets Debt Ratings Upgrade Following Handset Division Sale

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Nokia has had its debt ratings upgraded by Fitch Ratings to 'BB' from 'BB ', although the upgrade was expected as Fitch had put the company under review for an upward revision.

Fitch said that the rating actions follow the closing of the Devices & Services (handsets) disposal and announcement of the company's plans for disposal proceeds and ongoing capital structure. Fitch believes that Nokia's continuing operations reflect a more stable and visible cash flow, given the considerable drag on earnings and cash flow pressure exerted by handsets. The balanced approach taken in the use of disposal proceeds including extraordinary shareholder distributions of EUR2.25bn, along with the reduction of EUR2bn in debt, suggests a cautious approach to capital structure, with Fitch's rating case projecting net cash to be managed in excess of EUR5bn, subject to ongoing cash flow generation.

Fitch said that it views the turn-around at Networks (the networks business, which accounts for roughly 90% of group revenues) to be impressive; achieved through a wholesale restructuring of the cost base, a focus on profitable contracts and exit from unprofitable relationships and countries. With 2013 revenues down 18%, the company expects to stabilise revenues in 2H14. Sustaining financial metrics while stabilising or improving market share in a competitive industry, will be key to achieving a higher rating over time.

The Stable Outlook reflects Fitch's view that although financial metrics and capital structure are strong for a 'BB' rating, some uncertainty exists about the sustainability of the current margin and cash flow profile.

While the performance of Networks is well established, its performance has been achieved in part due to contracting revenues, where unprofitable business has been proactively exited. The Outlook therefore reflects caution over how margins and in particular working capital cash flows will perform in a market where Nokia's Networks division is expecting to stabilise and potentially grow its revenues.

Well Defined, More Visible Business

Continuing operations have an established track record, with Networks now accounting for approximately 90% of group revenues, having turned profitable in early 2012 and posting strong results over the past two years. The patents licensing division, Technologies, is a high margin business and is expected to grow to an annual run-rate of EUR600m in revenues following the Microsoft transaction. In Fitch's view, these businesses, along with HERE, the group's strategically important mapping business, will underpin the earnings profile of the group, with results expected to be far less volatile than the recent past given the disposal of the handsets business.

Networks Performance Key

Networks has performed well in a highly competitive market, with the turnaround in earnings and cash flow impressive. The strategic exit from unprofitable relationships and geographic markets, along with material cost cuts, has driven performance. Revenues in 2013 were down 18% while the (non-IFRS) EBIT margin of 9.7% was at the top of a guided target range of 5% - 10%. The key for Networks will be to sustain performance metrics now it is looking to stabilise and grow revenues. This will mean maintaining or improving market share in a market where competitors are prepared at times to sacrifice margins and incur weakened cash flow performance to secure long-term customer relationships.

Competitive Infrastructure Market

Nokia has refocused Networks, targeting the profitable and more visible mobile broadband networks market. Fitch views this market as polarising around the top-three competitors, which in addition to Nokia, include Ericsson and China's Huawei. The latter two exhibit far larger scale (albeit Huawei encompasses a far larger scope of revenues), allowing them to invest significantly more in R&D. Fitch believes both have been prepared to sacrifice margins in order to build market share. However, margins across the top three players have shown some stability, suggesting perhaps a more rational pricing environment. Nonetheless, Fitch believes competition will remain high, which will at times lead to margin and cash flow volatility.

Conservative Financial Policies

Nokia announced its plans for the disposal proceeds and ongoing capital structure along with its 1Q14 results. Plans to return a combined EUR2.25bn in extraordinary shareholder distributions (buybacks of EUR1.25bn and a special dividend of EUR1.0bn) have been balanced with plans to reduce gross debt by EUR2.0bn over the next two years. The re-instatement of an ordinary dividend, cash payment on 2013 results of EUR400m and a minimum payment of the same amount for 2014, suggest a degree of confidence in the underlying cash generation of the group. Fitch's rating case envisages net cash rising modestly from a base of around EUR5.25bn, providing a conservative financial structure and one that is a strong support for the ratings considering the industry is prone to macroeconomic and competitive shocks.

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