Nokia's CapEx Returns
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By TMFRichDad
February 7, 2007

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Hi Mike,

Nokia has no debt, it has net cash of EUR8.2Bn, and capex of EUR650m is less than depreciation EUR712m. ROE is 35%. Analysts have the growth rates at around 17% for 2007 and 14% for 2008, so I should be looking at Equity Re-investment rate around 50%, no? I can't really arrive at EUR2Bn+ for the dollars reinvested. I don't really understand the equations as Nokia are clearly growing the business, yet spending less on capex than the depreciation rate.

You may not think so, but I see light bulbs coming on for you. We are close. My first suggestion is to step back from the TTM or latest fiscal year numbers and look at a larger historical picture, perhaps 3 or 5 years.

First, in order to use the equations we need to:
a) keep the operations of the business in mind (how it works)
b) Use "normalized" or average levels for CapEx [capital expenditure] over time

For a) consider that NOK is for the most part a manufacturer and CapEx will often entail building a new manufacturing plant. Once built and operational, the plant does not go immediately from zero to full capacity instantaneously. In fact, that plant may not run near full capacity for several or even many years. So, the cash flow for NOK is that they spend a large amount on CapEx in one year and receive increasing returns (thru increased sales made possible by the increase in manufacturing capacity) over a time frame spanning at least several years.

Once the CapEx dollars are spent, necessary maintenance expenses start out rather low (not anywhere close to accounting's typical D&A expense of 1/30th of the initial cost). They ramp up gradually over time. But at some point the plant becomes inefficient or obsolete and requires a significant reinvestment for modernization or simply must be replaced, a situation that might not occur for 15, 20 or even 50 years.

My point here is that by simply taking the difference of CapEx - D&A reported in any single year may not give a good indication of the level of net reinvestment back into the business. CapEx is a very lumpy expenditure and must be averaged out over a number of years. For manufacturers, D&A at 1/30th (U.S. accounting's convention) of the purchase price is overestimated in early years and dramatically underestimated in later years.

Further, growth realized next year (or over a span of several years) can come from using up excess plant capacity requiring no CapEx in the previous year.

Some companies (and I can't recall if NOK does this or not) will report planned CapEx expenditures for the coming year. Keeping tabs on this data over time can give you a real feel for a more realistic level of the CapEx - D&A spread.

Analysts have 5-year growth estimated at 10%. eps in 2006 grew 27.7%, SFCF grew 23%. As I said analysts have eps growth at 17% and 14% for 07 and 08. It doesn't quite seem to tie in with the 10% 5-yr growth - maybe they derive the 5-year growth rate from the current share price and a DCF :-)

I know you were kidding but many analysts do indeed "adjust" their estimates with a close eye on the current stock price, making whatever changes are necessary to come up with a value of the shares of 10 or 15 percent higher than the current price, regardless of the underlying fundamentals. I never listen to them, except for one.

Yes, the per-share figures are likely to grow at much higher rates than my 8 to 12%. This is because NOK has been and likely will continue to buy back shares at a fairly high rate. This distorts the growth figures from reality and can lead to errors in valuation when the buybacks stop. The only way to fix that is to work with whole dollars and the outstanding share count separately, calculating per share value as the last step.

Anyhow if I do it that way, 5-yr 10% growth gives a fair value of $26.54, 10-year 10% growth gives $31.59.

I don't know anything for sure, but my hunch is that this range is probably very close to the intrinsic value of NOK, currently.

It would be interesting to do a stock screen on stocks with higher analyst growth rates predicted for the next year than their 5-year growth rates. If Nokia keeps hitting mid-teen growth rates analysts will have to change their 5-year growth estimates. It doesn't seem to me that Nokia has gone ex-growth and will only grow in line with economy, but the expectations built into current price appear to suggest that.

I agree that NOK has many more years of growth ahead of it. This growth will come to a great extent in Asia and India. I also think NOK is going to make inroads in the US. MOT is a strong competitor, though, and it will be interesting to watch.

An aside:

It is simple to describe all of this as I have just done. It is much harder to apply in practice. I wish I could help you more by providing my estimates for some of the key inputs to the valuation. But, I haven't gone to this level of valuation with NOK, ever. I bought my shares when Mr. Market was clearly throwing them away back in 2004. Because I got such a good price on the shares and because NOK is such a good company that I simply plan to hold on to the shares forever. I do closely monitor the big picture for NOK just in case I might need to sell. But, we are not there yet, not even close.

From this discussion, I can tell that you have an interest in learning more about the mechanics of estimating intrinsic value. One of the best sources of free information on this topic can be found here:

The books button will lead you to a screen where you can download pdf's of manuscripts of the Professor's books for free. Also, there are various lecture notes on a host of key topics. There is a spreadsheet button that will allow you to download a slew of valuation spreadsheets that attempt to model the various items we have briefly discussed.

Now, I hesitate to do this; please don't take it the wrong way. I hate it when the TMF articles do this all the time. But, the single smartest thing I ever did in my investing career and that has provided me with a wealth of investment knowledge was to join the TMF Inside Value subscription service. I just recently became a stroller on the IV boards. But just two weeks ago I was a paying customer. The IV boards are populated by a very knowledgeable, friendly and helpful group that could play an important role in your learning process on how to value a company. If you really want to learn how to value a stock, join IV and participate on those boards. I urge you to at least try the free trial and I would have done so even before they tacked the TMF in front of my name. FWIW, I get no commission or anything for how many I signup or anything like that. I simply see in you where I was just one year ago.

I don't know how much money you are working with. But if joining Inside Value gave you the knowledge whereby it kept you out of just one bad situation, or, if it found just one good company to invest in, would that amount saved or the amount gained likely be many, many times more than the subscription price over a years time?

Good luck to you in what ever you decide,


ps: Mike, if you do join be sure to look me up. I'm pretty easy to find on those boards.

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