The continued troubles facing Nokia were highlighted by its announcement yesterday that its Q212 devices and services operating margin will be less than the negative 3% of Q112, and of additional restructuring charges. This will lead to a precarious combination of a depleted cash balance without an end in sight to the declining cash flows, a situation that the company will need to rectify soon. 

Given the strategic challenges facing the company, these trends are not particularly surprising. We have previously said that the company must demonstrate that it is capable of stabilising revenue and generating positive low-single-digit operating margins if its rating is to be affirmed at ‘BB+’. Nokia’s announcement suggests that the company has moved further away from this position over the last two months. Developments relating to Windows 8 and a new suite of products appear crucial. 

The company’s rating is supported by its strong net cash position, which was EUR4.9bn at end-Q112.  We expected the additional restructuring charges, together with some further margin declines, to erode the company’s cash cushion to a certain extent. These were factored into our downgrade to ‘BB+’ on 24 April. However, continued strongly negative operating cash flow generation is not consistent with the current rating level as it puts too much pressure on this cash cushion. 

The company needs to return to generating positive operational cash flow in order to offset the removal of the support that the cash cushion, which is going to be reduced by the pending restructuring charges, previously gave the rating. If we are not convinced that the company can succeed in delivering this, we will take a negative rating action. 

The company plans to cut the Devices and Services annualised opex run rate to EUR3bn by end-2013, from EUR5.35bn in 2010. While Fitch recognises that these savings are credit positive and will help the company return to positive operational cash flow, Nokia needs to stop the revenue declines. 

Although the cost-cutting provides some relief, ultimately the company needs to demonstrate that its products are attractive to consumers and can enable it to win back market share. Nokia’s comments about its Q2 performance suggest that the company is not yet on this path.