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Ailing Finnish handset manufacturer Nokia Corporation (NOK - Analyst Report) continues its dismal run as Moody’s Rating Agency has downgraded it to “junk” status. We believe that the disappointing profit outlook posted by the company, coupled with its higher-than-expected cash outflow, are the primary reasons for the pessimistic view.

Moody’s has lowered Nokia’s long-term credit rating to “Ba1” from “Baa3” – the second ratings downgrade suffered by the company in three months. Moody’s is the third rating agency to reduce Nokia to non-investment grade status following Fitch and Standard & Poor’s in April. Relegation to “junk” status implies that Nokia’s creditability is doubtful and the company will not be favored by financial institutions.

Nokia is currently engulfed with problems and has been losing market share to Apple Inc.’s (AAPL - Analyst Report) iPhone and a gamut of smartphones that run on Google Inc.’s Android operating system. The company also faces stiff competition in the low-end segment from Chinese manufacturer ZTE. 

According to IDC, once the world’s largest handset manufacturer, Nokia has recently been overtaken by Korean giant Samsung Electronics in sales.

In an effort to improve its falling smartphone market share, the company ditched its Symbian operating system and teamed up with Microsoft Corporation (MSFT - Analyst Report) to develop Windows based smartphones. However, the recently launched Lumia is not expected to be a hit right away, as the company sold only 12 million handsets in the first quarter compared to Apple’s 35 million and Samsung’s 44.5 million.

In order to withstand this problem, Nokia has initiated several restructuring measures like retrenching 10,000 employees, shutting down its production and research and development units as well as divesting its 90% stake in its premium handset division Vertu. Additionally, Nokia plans to trim its huge patent portfolio which is being viewed as a desperate move to improve its fading cash position.         

Nokia is skeptical that the fierce competitive landscape could negatively impact its device and service business. The company expects its second quarter operating margin to be broader than negative 3.0% in the first quarter. Furthermore, the company stated that it might have to shell out more money, if the Nokia-Siemens joint venture continues to escalate its operating cash flow.

Despite the comprehensive restructuring initiatives undertaken by the cell phone maker, the above mentioned issues are believed to be the primary reasons for Nokia’s rating downslide.

Recommendation:

We retain our long-term Underperform recommendation on Nokia. Currently, Nokia has a Zacks #3 Rank, implying a short-term Hold rating.

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