Musings on AAPL

In these weirdest of times, it is important to emphasis again Charlie Munger’s words of wisdom that “nobody knows what’s going to happen”. As developed countries across the world experiment with easing lock down measures, thoughts are moving to how economies can be re-opened. In what The Economist this week calls a 90% economy, they reflect upon a world where “the office is open but the pub is not”. A trite comment maybe but one that I think succinctly captures the new normal that those of us lucky enough to have our health can hope to be in for the next year.

Anyway, the point is that any projections in this environment are purely speculative. Add in my spotty record with AAPL, as this post in November attests to, and that AAPL have pulled guidance, highlights the likely futility of this post! Actually, I did dip my toe back in the water on AAPL around November after that post and when it shot up past $310 in January, I thanked the Gods and cashed out again (it went as high as $327 in February, daft!). The optimism about a new 5G iPhone super-cycle for next year that fed into that share price ramp has now been tempered by, well, the virus thing.

For my projections, I have assumed 26 million iPhone sales in the current quarter, down 27% on 2019, and 162 million for FY 2020, a 14% reduction from FY 2019. For FY 2021, I have assumed a pick-up in yearly unit iPhone sales due the launch of 5G iPhones, some in time for the holiday season, but at 180 units for FY 2021 it’s far short of the anticipated super-cycle refresh due to depressed consumer demand as the recession plays out next year. My assumptions are shown below:

These assumptions are further illustrated in the trailing 12-month graph below.

Every great company needs an edge in the coming months and years to thrive. For AAPL, in addition to the quality of their products and their loyal installed base, their cash pile and their ability to manipulate share count through buy-backs has been a particular feature of their financial success in recent years, as the graph above clearly shows.

Although analysts were expecting a $75-100 billion increase in their buy-back programme in the Q2 quarter announcement last week, the announced $50 billion shows discipline and caution from management. I estimate that AAPL has spent approximately 130% of free cash-flow on dividends and buybacks in aggregate over the past 6 quarters, reducing their net cash balance by approximately $50 billion to $83 billion over those 6 quarters.

For the next 6 quarters to the end of FY 2021, I am assuming they return to shareholders, through both dividends and buy-backs, a similar amount of $126 billion to the previous 6 quarters, $105 billion through buy-backs alone. This shareholder return in terms of free cash-flow earned over the next 6 quarters would be an eye popping 200% according to my estimates. I further estimate a reduction in net cash on the balance sheet to approximately $40 billion by the end of FY 2021, an amount which I believe management, to be consistent with the firm’s DNA, should not feel comfortable going below for prudence sake (or to avail of further accretive M&A opportunities). One of the lessons of the COVID19 outbreak for well managed firms is surely the need for a contingency buffer against the unexpected. The resulting impact upon diluted share count and EPS of these assumptions at differing average buy-back share prices is shown below.

So, that just leaves the question of valuation. I will again warn that the subject matter in this post is based upon my assumptions which are highly speculative. I have proven myself to be hopelessly wrong in relation to AAPL at certain points in the past, so this time is unlikely to be any different! Using my preferred forward PE multiple excluding cash per share methodology, the graph below shows the forward multiples of my assumed performance over the next 6 quarters at share prices from $150 to $400, in increments of $50. The “increased love trend” is reflective of the higher multiple that AAPL has received as their service business has expanded and the hybrid hardware/software valuation has evolved.

Based upon this analysis, I would suggest that a share price below $250 should be considered as an entry point. Currently, I am uber bearish on equities and have exited 90%+ of my positions, taking advantage in recent weeks of this fairy tale rally (I mean, where is the upside from here?). Were AAPL to fall below $250, I would look closely at it again, albeit at a still heightened forward PE just below 18 based upon my estimates. Whether such an opportunity is afforded is anybody’s guess. As the man said, nobody knows.

A string of worst evers

As the COVID19 deaths peak, in the first wave at least, across much of the developed world the narrative this week has moved to exit strategies. The medical situation remains highly uncertain, as the article in the Atlantic illustrated. A core unknown, due to the lack of extensive antibody testing, is the percentage of populations which have been infected and the degree of antibodies in those infected. What initially seemed to me to be a reasonable exit framework announced by the US has been fraught with execution uncertainty over the quantity and quality of the testing required, exasperated by the divisive ramblings of the man-child king (of the Orangeness variety).

The economic news has been dismal with a string of worst ever’s – including in retail sales, confidence indices, unemployment, energy and manufacturing. The number of turned over L shaped graphs is mind-blowing. And that’s only in the US! The exhibit below stuck me as telling, particularly for an economy fuelled by consumer demand.

In the words of the great Charlie Munger: “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.” The equally wise Martin Wolf of the FT, who penned an article this week called “The world economy is now collapsing” posted a video of his thoughts here. His article was based upon the release of the latest IMF economic forecasts, as below.

The IMF “baseline” assumes a broad economic reopening in the H2 2020. The IMF also details 3 alternative scenarios:

  • Lockdowns last 50% longer than in the baseline.
  • A second wave of the virus in 2021.
  • In the third, a combination of 1) and 2).

The resulting impacts on real GDP and debt levels for the advanced and emerging/developing countries respectively are shown below.

A few other interesting projections released this week include this one from Morgan Stanley.

And this one from UBS.

And this one from JP Morgan.

In terms of S&P500 EPS numbers, this week will provide some more clarity with nearly 100 firms reporting. Goldman’ estimates for 2020 compared to my previous guestimates (2020 operating EPS of $103 versus $130 and $115 in base and pessimistic) were interesting this week given the negative figure for Q2 before returning to over $50 for Q4. The “don’t fight the fed” and TINA merchants amongst the current bulls have yet to confront the reality of this recession for 2021 earnings where the fantasy of an EPS above $170 for 2021 will become ever apparent with time in my opinion. Even an optimistic forward multiple of 14 on a 2021 operating EPS of $150 implies a 25% fall in the S&P500. And I think that’s la la land given the numbers that are now emerging! We’ll see what this week brings…..

Stay safe.


This article in the Atlantic magazine by Ed Yong is excellent. Much food for thought on the issues for the months ahead.

Peak Uncertainty

As we face the peak weeks of the COVID19 virus in the major developed economies, one thing the current COVID19 outbreak should teach us is humility. As humans, we have become far too arrogant about our ability to shape the future. A new book by the economists John Kay and Mervyn King (a former Bank of England governor during the financial crisis) called “ Radical Uncertainty” argues that economists have forgotten the distinction between risk and uncertainty with an over-reliance on using numerical probabilities attached to possible outcomes as a substitute for admitting there are uncertainties we cannot know. How many one in a century events seem to be happening on a regular basis now? Their solution is to build more resilient systems and strategies to confront unpredictable events. Such an approach would have a profound impact on how we organise our societies and economies.

Currently, planning for events with a large impact multiplied by a small probability allows us to effectively continue as we have been after assigning the minimal amount of contingency. Imagine if sectors and industries were run based on been prepared for tail events. That would be a radical change. Very different from our just in time supply chains which minimise capital allocation and maximise return on investment. Our approach to climate change is an obvious case in point and how we have heretofore ignored the environmental externalities of our societies and economies. Given the financial costs this crisis is going to place on future generations, I would suspect that the needs of this cohort of our society will become ever more urgent in the aftermath of the COVID19 pandemic.

As many people grapple with the current uncertainties presented by this pandemic, we are currently at peak uncertainty in Europe and the US. We are only now getting a sense of how the outbreak is peaking in Europe given the lock down measures in place. How the virus reactions to the relaxation of current measures, how the outbreak will peak across the US and other continents, the economic impact of the outbreak, or the societal impact amongst many other issues are as yet unknown. We do know however that with time over the coming weeks some of these answers will become clearer. For example, as the graph below from the FT shows, we known the approximate path of the outbreak given the policies being pursued today.

A positive narrative could be that existing medications pass rushed COVID19 trials and prove they can blunt the impact of the virus thereby altering the shape of the curve. We can also speculate that once the first wave is contained, we will develop strategies on a combination of mitigation measures (e.g. reduced isolation methods, antibody and other testing to return sections of the population to work, immunity passports, etc) to slowly transition to the new normal. The logistics of such a phased return to normal will be complex and a nightmare to enforce, particularly if self-isolation measures are in force for lengthy periods and people believe any second wave can be well contained by battle hardened health systems. We can be confident that a vaccine will be developed, hopefully by early 2021, but it will take time to get the vaccine distributed and administered in bulk. Mid 2021 is likely the best we can realistically hope for.

At this stage, my rough guess at a base case scenario on the timing for European and US lockdown is 3 to 5 weeks with another 6 to 10 weeks to transition to a semi-new normal. That’s somewhere between mid-June and early August with Europe leading the way followed by the US. A more pessimistic case could be that discipline amongst the population gets more lax as the weeks drag on and a second wave gathers momentum with a second lockdown required over the summer followed by a more timid and gradual transition afterwards lasting until the end of the year. Obviously, these timings are pure guesses at this time and may, and hopefully will, prove way off base.

The economic impacts are highly uncertain but will become clearer as the weeks pass. For example, with just the first fiscal stimulus package passed in the US, the politicians are already listing their priorities for the second (and likely not to be the last either), Morgan Stanley expect the cyclically adjusted primary fiscal deficit to rise to 14% of GDP and the headline fiscal deficit at 18% of GDP in 2020, as per their graphic below. Given the unknown impact of the crisis on GDP numbers, these percentages could approach 15% to 20% with total debt of 110% to 120%. It’s depressing to note that prior to this crisis the IMF said the U.S. debt-to-GDP was already on an unsustainable path.

Although the euro zone comes into the crisis with less debt, last year it was 86% of GDP, Jefferies said in a ‘worse case’ outcome where nominal GDP falls 15% this year, the bloc’s budget gap would balloon to 17% of GDP from just 0.8% last year. They estimate in this scenario that the euro zone debt-GDP ratio could rise above 100% in 2021. As a percentage of GDP, Morgan Stanley estimated the G4+China cyclically adjusted primary deficit could rise to 8.5% of GDP in 2020, significantly higher than the 6.5% in 2009 immediately after the global financial crisis. Unemployment rates in the short term are projected to be mind boggling horrible at 20%+ in some countries. It seems to me that the austerity policies pursued after the financial crisis will not be as obvious an answer to repayment of this debt, not if we want western societies to survive. Addressing generational and structural income inequalities will have to be part of the solution. Hopefully, an acceleration of nationalism wouldn’t.

On the monetary side, the Fed’s balance sheet is now estimated to be an unprecedented $6 trillion, an increase of $1.6 trillion since the start of the Fed’s unprecedented bailout on the 13th of March. Bank of America estimates it could reach $9 trillion or 40% of GDP, as per the graphs below.

As to corporates and the stock market, dividends will undoubtably be under pressure as corporate delevering takes hold and without the crack cocaine of the bull market, share buybacks as the graph below shows, I fear there will be more pressure on valuations. The Q1 results season and forward guidance (or lack thereof), although it may have some surprises from certain firms in the communication, technology and consumer staples space, will likely only compound the negativity and uncertainty.

Using unscientific guesses on my part, I have estimated base and pessimistic operating EPS figures for the S&P500 as below. Based upon a forward PE (on a GAAP EPS) of 15 (approx. 12.75 on operating EPS basis), which is the level reached after the dot com bubble and the financial crisis, the resulting level for the S&P500 is 2,000 and 1,600 in the base and pessimistic scenarios respectively. That’s a further 20% and 35% drop from today’s levels respectively.

The coming weeks will likely be horrible in terms of human suffering and death across the developed world (one cannot even comprehend the potential suffering in the developing world if this insidious virus takes hold there). There is always hope and uncertainty will reduce over time. Major decisions will need to be made in the months and years ahead on the future of our societies. Learning from this pandemic to build more resilient societies and economies will be a task that lasts many years, possibility even generations. Major changes are coming after this health crisis subsides, hopefully they will be for the better.

Stay safe.

Where to now?

There can be little doubt that March 2020 will go down in history. I fear that April 2020 will bring more pain and suffering across this little planet of ours. I have, like I am sure you have also, looked on in horror as events unfolded over the past weeks and felt emotions I never thought possible as I fear for family, friends and communities. We have to hope that medical science will come to assist us with treatments to take some of edge off this insidious pandemic until we can mass produce and distribute a vaccine for COVID19.

Until recent days, I have not had the stomach to sit down and try to read up on how this nightmare may end. The data, both medical and economical, that will come out in April will likely shock but will hopefully at least help us to figure a route out of this. Right now, I doubt we will ever go back to the world we lived in just a short few weeks ago. The price that will have to be paid for this human tragedy once the virus is conquered will, I fear, include destroyed businesses, unemployment, financial hardship for many and a debt crisis (both corporate & sovereign). If things get really bad, I would fear for social cohesion in the months and years ahead in many communities and countries. So, in trying to start to figure out where we go to now, the exhibits below are those I have taken from some recent reports (as credited) that I thought worth sharing.

Notwithstanding these fears, I do think it’s important to have hope and there are many things happening during this crisis that point to hope. Families getting stronger through adversity and a focus on what is important for us all are just two positives. We’ll see what the coming weeks bring….

Stay Safe.

Deloitte US GDP Forecasts