Fitch Ratings has downgraded Nokia’s Long-term Issuer Default Rating (IDR) and senior unsecured rating to ‘BB-‘ from ‘BB+’. The Outlook on the Long-term IDR is Negative.
Fitch had previously guided that it would take a negative rating action if it was not convinced that Nokia could stabilise the revenue declines and be capable of generating positive single digit operating margins in its Devices and Services division. The release of Nokia’s Q212 results indicate that the company is currently not near this position and Fitch is not convinced that this can be attained anytime soon.
Nokia’s net cash position of EUR4.2bn and gross cash of EUR9.4bn at Q212 is strong and is currently supporting the rating. This is expected to be eroded significantly by restructuring charges over the coming two years. Also, the company’s operating margins are negative. Non-IFRS operating margin fell to -9.1% in Q212 from -3.4% in Q112, although inventory related write-downs did negatively affect Q2 margins. If these operational losses are not reversed, the support that the cash cushion gives the rating is going to be eroded faster, which could lead to further downgrades.
Fitch believes that the company does not have products in its current portfolio that can stem the recent losses. The release of a Windows 8 suite of products now appears crucial. However, the degree of competition in the industry would suggest that it is going to be difficult to re-establish a significant presence in the smartphone market. Numerous handset makers have issued profit warnings recently. For Nokia, an adjusted gross margin profile of around 16% in its Smart Devices division is unlikely to support a profitable smartphone business and Fitch remains unconvinced of Nokia’s ability to improve pricing in this segment. Furthermore, the announcement that the current batch of Lumia devices will not be able to upgrade to Windows 8 is likely to put additional pressures on Nokia in the coming quarters.
Given all of these headwinds, there is a significant risk that the company’s performance will continue to deteriorate. Despite the size of the company’s restructuring initiatives, including a targeted reduction in Devices and Services operating expenses to a run-rate of EUR3.0bn by YE13, Fitch is currently not convinced that the company will be able to stabilise revenues and reach an operating profit breakeven point. The Outlook is likely to remain Negative until this is foreseeable.
What could trigger a future rating action?
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
If Fitch does not believe that Nokia is capable of stabilising the revenue declines and halting the operational cash burns at some stage in 2013, then further negative rating action could be taken. The expected new suite of products must show that it is attractive to consumers and that it can win back market share. If this fails to materialise, further downgrades are likely.
The maintenance of the net cash position is also key. If the company does not look like it can maintain a positive net cash position, then a negative rating action could also be taken.