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Nokia Upgrade Sends Stock Hopping: 3 Things You Need to Know

By Rich Smith - May 25, 2016 at 1:00PM

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The Finnish icon is in flux as it absorbs Alcatel-Lucent -- and it may be too soon to buy.

Stock market indexes are glowing green this Wednesday morning -- but few stocks are doing quite as well as Nokia Corporation (NOK 1.08%). Boosted by a new buy rating out of Chinese investment house CLSA, Nokia shares have soared 3.7% in early trading.

But what was the basis for CLSA's upgrade? How high do they think the stock can go -- and are they right?

Here are three things you need to know.

"What's that you say? Nokia stock is a buy?"

Thing No. 1: Who's in the mood for a 15% profit?

CLSA did a complete 180 in its thinking on Nokia stock this week, upgrading the shares all the way from underperform to outperform (i.e., from sell to buy). Such dramatic turnarounds are rare on Wall Street, where analysts more usually shift their stock ratings one notch at a time -- but CLSA is going whole hog.

According to its write-up on this morning, CLSA has increased its valuation estimate for Nokia by 16%, to $6.25 per share. If it's right about that, the stock -- up nearly 4% already today -- still has another 12% worth of profit left in it. Add in a respectable 3.3% dividend yield, and potential profits rise to 15%.

Thing No. 2: Why?

That's the big question, of course: Why does CLSA like Nokia so much? Well, it all goes back to the company's acquisition of Alcatel-Lucent (which finally closed in January), and to the "synergies" CLSA expects Nokia to extract from the merger of the two companies.

Earlier this week, Reuters reported that Nokia plans to lay off somewhere between 10,000 and 15,000 workers over the next couple years. That's bad news for the workers laid off, but for Nokia shareholders, it opens a path to the company cutting about $1 billion in annual operating costs from its budget.

Thing No. 3: What would that mean for the stock?

According to data from S&P Global Market Intelligence, Nokia earned about $2 billion over the past 12 months. If all the dollars saved on labor expense were to fall to the bottom line (they probably won't, because the tax man will lay claim to at least some of the extra operating profit), Nokia's "synergies" could potentially add 50% to the company's annual profits.

CLSA further cites guidance from Nokia management, predicting "above 7%" operating profit margins in the company's flagship networks business as boosting its confidence that Nokia's profits will grow through 2017 and 2018.

The most important thing: Is that enough?

But here's the thing: Right now, S&P Global data show Nokia earning 11% operating profit margins at networks. Alcatel, meanwhile -- the company Nokia is taking over -- earned just over 7% profit margins itself last year. Given this, Nokia promising to earn "above 7%" profit would seem to be a pretty hollow promise. You'd think that with one half of the business earning 7% already, and the other half earning 400 basis points more, "above 7%" profit margins from the whole would be a given.

Nokia's promise to achieve a goal it's already hitting, therefore, is far from impressive. The more so if it thinks it may need $1 billion in cost-cutting to continue meeting that goal.

Nokia stock today looks like a bargain at less than 12 times earnings. That number, however, is based on the $0.35 per share that Nokia earned last year, before absorbing Alcatel. Post-merger, most analysts who follow the company are predicting a steep dive in per-share profits this year (to just $0.06 per share), followed by a gradual return to growth thereafter. Even so, analysts (CLSA perhaps excepted) don't generally see Nokia surpassing last year's level of per-share profits before 2020.

Seems to me, that's a long time to wait for Nokia to outperform. I think CLSA is jumping the gun with its upgrade.

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