Note: This post was prior to Apple’s 7 to 1 stock split.
Sentiment plays a massive role in Apple’s market value. This time last year, the market was fretting about AAPL’s over-reliance on the iPhone in a maturing smartphone market, declining gross margins, and a lack of visibility into new product categories.
AAPL’s success in China, the stabilisation in gross margins and its increasing shareholder friendly buy-back/dividend policy have overcome many market apprehensions. Although the iPhone’s global market share is down to approx 15% after competitors gained most from the over 30% growth in global smartphones sales, AAPL shares have gained over 12% after the latest quarterly results on strong iPhone sales of almost 44 million units (17% year on year iPhone growth).
The much speculated iWatch (or similar wearable type orientated towards the health conscious device) doesn’t now look likely to be launched until late 2014 or early 2015. The Q2 sales of iPads were also well below expectations. Notwithstanding these issues, it is the forthcoming refresh of the iPhone product line (i.e. iPhone 6), which may include bigger screen options, that has some analysts excited. Morgan Stanley recently published the graphic below to highlight the upgrade potential in the US.
I have posted before (here and here) on AAPL’s valuation but the lack of visibility into Apple’s trajectory is reflected in my lack of conviction on the stock. I do however think that Apple is a fascinating investment case study and worthy of some analysis. My previous attempts at some basic DCF valuation selected projections based upon my assumptions of the future.
This time, I wanted to take a stab at projecting figures which I believe are reflected in the current (more optimistic) market thinking. For example, I have assumed that Apple can broadly maintain its current gross margins across its products in the future. I have also assumed that a new wearable product, let’s call it the iWatch for convenience, would be available from 2015 and would track the iPhone user base (starting at 20% in 2015 or 35 million units and growing by 5% of the iPhone user base a year thereafter). I have assumed a $300 retail price for the iWatch and a 30% gross margin. The projections for all unit sales are represented in the graph below.
The associated revenue projections, assuming moderate unit price declines of between 1% and 2% per annum depending upon the product, are therefore as per the graph below
Keeping all other major financial assumptions at the current levels (for example, SG&A and R&D as a percentage of revenue, cash-flow generation, etc.) and, assuming an approximate assumed market discount (risk) rate of around 7% and a termination multiple of 5 times the 2023 PV cash-flow, the exhibit below shows how a $600 AAPL share price could be justified using a basic DCF valuation. The PE ratios are based off average analysts EPS estimates for 2014 from Yahoo finance.
The question therefore is whether the unit sale projections, and to a lessor degree the other assumptions, above are a reasonable basis for investing? As stated earlier, my conviction on Apple is not high enough to answer that question. Is yours?