Expanding margins and market share

Since our last review (FAT77), the stock price of the world's largest mobile phone maker, Nokia (NOK), has continued to post strong gains. Most recently, investor enthusiasm for the company received a boost following an outstanding third quarter result that exceeded market expectations.

...the company enjoys a greater market share than its three largest rivals combined!"

As shown on the charts, a continuation of the three-year upward trend has seen prices reach as high as $39.93 this month. This is the highest level attained since 2001 and represents an 82 percent gain since our initial buy recommendation at $21.90 in August

In the three months to 30 September, the company generated net earnings of 1.56 billion euros, up an impressive 85 percent on the 845 million euros earned in the same period last year.

More significantly, the substantial earnings growth came from revenue expansion of just 28 percent. In fact, Nokia's average selling price per unit fell from 90 to 82 euros over the period, following increased volume of lower end models.

Despite the lower average selling price, the company's current product range is more profitable than before. Highlighting this, the net profit margin expanded from 8.4 to 12 percent over the period.

Furthermore, Nokia's share of the global handset market has now grown from 36 to 39 percent over the last year. In fact, the company currently dominates the market with a greater share than its three largest rivals combined!

The table below shows the company's sales volume by geographic region.

[[Region]] [[Q3 2007]] [[Q3 2006]] [[Change (%)]]

[Europe ] [29.0] [24.8] [16.9]

[Middle East & Africa] [19.3] [13.3] [45.1]

[China] [18.9] [13.8] [37.0]

[Asia-Pacific] [29.5] [20.9] [41.1]

[North America] [5.4] [5.8] [-1.7]

[Latin America] [9.6] [9.9] [-3.0]

Sales volumes are in million units

Source: Nokia

As the data indicates, Nokia's strongest growth was generated from emerging markets such as India (included in Asia-Pacific) and China. And given our view of these areas' long term growth prospects, we expect these markets to underpin continued sales growth in the months and years ahead.

Nokia's ability to capture such a significant portion of the market is particularly impressive considering the success of rival Motorola just a few years ago. Motorola looked set to mount a considerable challenge to Nokia following the release of their top selling Razr product. Since then however, Nokia has continued to launch innovative and popular products, while Motorola failed to backup their initial success.

Nevertheless, the fact that the competitive landscape can change so swiftly highlights the importance of continued product development. And on this front Nokia are certainly not resting on their laurels. Indeed, CEO Ollie-Pekka Kallasvuo recently stated that the organization remains "paranoid" about the threat posed by their competitors.

Meanwhile, the phone-equipment joint venture between Nokia and Siemens AG (Nokia Siemens Networks) took the gloss off the result somewhat. The JV posted a loss of 120 million euros on sales of 3.67 billion euros. Although the result included an 86 million euro charge for redundancies, expectations are for further restructuring costs in the months ahead.

Moving forward, management's strategy for future growth is to evolve the company from a pure hardware operation to one that includes software and services. In respect of which, Nokia recently introduced their new internet services brand, Ovi (meaning 'door' in Finnish).

In conjunction with Ovi, Nokia announced the introduction of an online music and games service, which will include some exclusive content. In addition, management have made a series of acquisitions, including mobile advertising company Enpocket and mapping navigation business NAVTEQ.

While still early days, we view the move into software and services as a logical development for the company that should prove positive for shareholders. Not only will such a strategy introduce an additional source of revenue, combining mobile devices and services should improve brand loyalty and customer retention.

Turning to the fundamentals, the company is certainly in sound financial health. As at 30 September 2007, Nokia's balance sheet had a net cash position in excess of 800 million euros. As such, management may choose to make further acquisitions should suitable opportunities present themselves.

In terms of the valuation, consensus estimates are for a 2009 price to earnings ratio of 15.5 times and dividend yield of 2.1 percent.

Returning to the charts, following a temporary pause for consolidation from mid September, upward momentum has returned over the past two weeks While we cannot rule out near term volatility, we believe firm support in the region of $35 will serve to limit downside risks.

As shown on the weekly chart, Nokia is continuing to lift away from a long-term base formation. With a strong three-year uptrend in place, we believe that substantially higher levels are attainable in time.

Accordingly, Nokia will remain firmly held in the Fat Prophets Portfolio.