Revenues and earnings fell, but the Finnish mobile-phone giant's guidance prompts a relief rally. Handset sales grew in emerging markets

Investors were undeniably nervous heading into Nokia's third-quarter earnings release on Oct. 16. Against a global backdrop of volatile trading in stock markets, shares in the Finnish mobile-phone giant had lost nearly a third of their value in the past two months—outpacing a 24% decline for the S&P Europe 350 index over the same period.

Some of the blame fell on a Sept. 5 warning from Nokia (NOK) that it expected to lose market share and report lower profits for the quarter. But investors also worried that the ongoing global economic turmoil could pull the rug out from under Nokia's sales—a concern now facing the broader consumer electronics industry as it heads into the crucial holiday season.

Yet when the third-quarter results finally were revealed, showing a 5% year-over-year decline in revenues and 30% drop in net income, investors were sufficiently gratified to drive up Nokia's New York-traded shares by nearly 10%. That such soft numbers provoked a relief rally indicates how pessimistic shareholders were. "The fact that guidance remained by and large unchanged gave some comfort to the market," says Richard Windsor, a London-based technology analyst with brokerage Nomura Securities.

Consumers Are Still Buying Handsets
It's not merely a matter of seeing the glass as half-full. Though revenues, at €12.24 billion ($16.48 billion) came in 3.9% shy of market expectations, earnings per share were spot on the mark, gross profit margins for handsets grew slightly, and operating margin was better than in the previous quarter. In other words, Nokia wasn't even close to a meltdown: In a tough market environment, the company managed to keep profitability on track despite a decline in volume.

More important, Nokia reassured the market that there's no wholesale collapse taking place in handset demand. Its own unit shipments in the quarter grew by 5%, even as revenues slipped, and executives repeated their prediction that the mobile-phone market as a whole will grow 10.5% this year, to 1.26 billion units. That implies 14% unit growth in the fourth quarter compared to the third—somewhat lower than historical norms, but still a huge vote of confidence in consumer spending at a time when many indicators are pointing downward. Nokia promises to maintain or grow its estimated 38% third-quarter market share in the last three months of the year.

To be sure, there are trouble spots. Sales in Europe—traditionally Nokia's stronghold, although China is now its largest single market—fell by a worrisome 5.5% vs. last year's third quarter. (Sales in the U.S. were even worse, down 16.7%, but that was due primarily to the company's exit from CDMA phones; units were flat vs. the second quarter.) "The financial crisis has affected U.S. and European markets," said Nokia Chief Executive Olli-Pekka Kallasvuo in an interview.

Cheaper Models Are Selling Better

At the same time, Kallasvuo noted, "many economies are still experiencing rapid GDP growth, even as we speak." The proof is in the numbers: Year-over-year unit sales growth in Latin America was 14.6%, while the Asia-Pacific region, excluding Greater China, grew 13.9% and the Middle East and Africa climbed 11.4%. These aren't piddling markets, either: The three regions together accounted for 56% of Nokia's total volume.

Faster growth in emerging markets does carry one downside: The prices customers there pay for phones tend to be lower. That's one reason Nokia's closely watched average sales price slipped slightly in the quarter—to €72 ($96.90), from €74 in this year's second quarter—as its product mix tilted more toward cheaper models. But compared with previous downward lurches, the drop left analysts unconcerned. "It was actually moderate," says Geoff Blaber, an analyst with mobile market consultancy CCI Insight in Britain.

Nokia admitted in its Sept. 5 market warning that it faced stiff price competition from rivals, but insisted it had opted out of a profit-killing price war at the low end of the market in favor of maintaining decent profits. Analysts now say that in the context of the current stock market, Nokia's strategy looks pretty smart.

After all, with investors ready to pounce on any sign of balance sheet weakness, it's more important these days to maintain or increase profits than to grab money-losing market share. Industry insiders say the most aggressive discounters have been Korea's Samsung Electronics and Swedish-Japanese joint venture Sony Ericsson. When they report results in upcoming days and weeks the damage to their bottom lines may be visible.

Demand in Emerging Markets

Nokia, on the other hand, spun out €1.3 billion ($1.75 billion) in cash during the third quarter and enjoys operating margins nearly twice those of its nearest competitor. Much of this is due to its sheer size and scale, which afford massive purchasing power and manufacturing efficiency. But the company also enjoys the benefit of being the world's fifth-most-valuable brand and huge research and development resources that allow for a constant stream of product launches.

Those advantages won't protect even giant Nokia if the global economy goes into the tank and consumers freeze up. The company may indeed be set for a rough patch in the West: Analyst Blaber says the weak third-quarter results in Europe and the U.S. "underline the fact that renewals are slowing," because consumers are scaling back on discretionary upgrades to new phones.

But even as developed economies head into recession, the surging prices for food and energy that depressed mobile-phone sales in poorer countries last year have receded, reopening demand in those markets from aspirational buyers with more disposable income. As Kallasvuo took pains to note in a conference call with financial analysts, "This is not a one-size-fits-all situation."

Still, he added, referring to the continued financial crisis: "We would be naïve if we ignored what is happening in the macroeconomic environment in many markets. We are fully prepared and are acting accordingly. In this time of economic uncertainty, I like our relative position."

Source:BusinessWeek