Tag Archives: AAPL

Peak iPhone

This will be a very interesting week on the stock market, not least the US mid-terms and the ongoing US/China trade saga, which will likely determine the short-term direction of the market. Apple (AAPL) reported last week and another stellar report was hoped for to calm technology weakness. Instead of a stellar report the market got weak Q1 guidance and the news that AAPL would drop detailed product reporting for their FY2019. Given that there is a massive industry dedicated to examining iPhone trends, the lack of specific numbers being disclosed has caused consternation amongst commentators.

It has been about a year since I last posted on AAPL (here) when it traded around $170. Of course, it has since traded up to a high of $230 before falling back to just above $200 currently. There is no doubt that the smartphone market is saturated with IDC estimating global smartphone shipments falling in Q3 by 6% to 355 million unit. In this environment, it makes sense to me for AAPL to focus on higher value smartphones and to extracting increased fees from services on their installed base. Extrapolating on the iPhone installed base analysis from my last post, I estimate that the iPhone installed base will peak around 650 units based upon iPhone unit sales fall to 200 million and 190 million in FY2019 and FY2020 respectively from 218/217 million in FY2018/2017. The active installed base, excluding non-core users, peaks around 570 million. My projections are shown below.

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I have also assumed that the ASP for FY2019 and FY2020 increases to $819 and $847 respectively from $759 in FY2018. I further assumed that service revenue increases as a percentage of total revenue to 18% for FY2020 from 14% in FY2018. I suspect this may be too light given AAPL’s decision to move its reporting focus away from products to services. Although AAPL’s net cash pile is slowly dwindling (approx. $120 billion at end September from $170 billion at the end of December 2017), I think a more focused move by AAPL into the home and content to take on Netflix and Amazon will be a feature of the next few years (bring on the NFLX rumours, again!). My resulting quarterly revenue estimates into FY2020 are shown below.

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As you can see, these estimates do show overall revenue moderating with revenue for FY2019 and FY2020 at $270 billion and $273 billion respectively from $266 billion in FY2018. My diluted EPS estimates, assuming the same trend of share buy-backs, for FY2019 and FY2020 are $13.30 and $14.80, representing EPS growth of 12% and 11% respectively. These EPS estimates are consistent with current consensus. At a share price of $200, the forward PE would be 15 and 13.5 for FY2019 and FY2020 respectively.

My usual forward PE excluding cash graph, at an AAPL stock price of $200, is below. If AAPL were to return to its historical average multiple since 2009 of 9, then AAPL’s stock could fall back to $160 or below if the market gets really spooked about peak iPhone.

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The question therefore is how the market is going to react to AAPL’s attempt to move the focus from its hardware results and more towards its service business from its massive and loyal installed base. Changing the market’s obsession from iPhone sales will be no easy task. AAPL is an emotive stock, not only because of its products but for its incredible historical value creation. It is the one stock that I have always regretted selling any of. I do not think now is the time to sell AAPL but I will wait for the stock price to settle, particularly in the current volatility, to consider buying more. A fall towards $170 would be too tempting to ignore for this wonderful firm. Mr Buffet and the firm’s own buy-back programme make such a fall unlikely in my view but one can only hope!

An Apple Appetite

Recently I have been trying to dig deeper into Apple (AAPL) to get a handle on what the near term may mean for this amazing company and thereby get an insight into APPL’s valuation. I have struggled with AAPL’s valuation in previous posts (here and here) but after each of my musings the share price continued on its upward trajectory.

Irrespective of whether iPhone 8 and iPhone X unit sales disappoint (due to unit shortages or otherwise) over the coming months, it seems highly probable to me that Apple will be successful in segmenting their iPhone market further over the medium term and break through the $1000 per iPhone spend in a significant way. Their R&D spend of over $10 billion (including nearly $2 billion of share options) goes a long way to ensuring customers will pay for their innovations.

The reason why AAPL are following the current strategy is a hot topic of debate with analysts. Some see the new iPhone models feed into a super-cycle of updates and continued installed base growth, pointing to the approximate 40% of the current iPhone installed base older than 2 years. Other analysts believe that the smartphone market has plateaued (see graph from Mary Meeker below) and Apple is embarking upon a segmentation strategy to harvest their loyal customer base.

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The estimates for the iPhone installed base vary significantly across analysts from 550 to 750 million units and some, such as Deutsche Bank and BoA ML further, break the base down to core and secondary non-core users. Although most of the estimates are likely out of date as they were published prior to the iPhone 8 and iPhone X announcements, the graphic below illustrates the differing views.

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It is likely no surprise that I am in the plateau camp on future growth of the installed base. I have assumed an installed base of 640 million as at end September 2017 and 40% or approximately 250 million of these are potential iPhones upgraders with phones older than 2 years. I have further assumed that a proportion of the installed base, I selected 10%, are secondary non-core users with a very low propensity to upgrade. That leaves an approximate 190 million potential upgrades for the FY2018. Despite the lack of growth of the market, I assumed another 10 million sales from new purchasers giving a target iPhone unit sales of 200 million for FY2018. 200 million of annual unit iPhone sales is well below most analyst estimates which average around 240 -260 million for FY2018.

Of the 200 million iPhone unit sales for FY2018, I have further assumed 45 million are iPhone X and just over half are iPhone 8, with the remainder being iPhone 7 and older models. For Q42017, I am assuming only 9 million iPhone 8 sales with 35 million of iPhone 7 and older models (influenced by the amount of inventory clearance sales I have seen in retail stores). The graph below shows my installed base assumptions, with my estimates for sales of the iPhone 8, iPhone X and it successor models over FY 2018 and FY2019 (I am assuming 200 million units is the new normal for annual iPhone sales through to FY2020).

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The resulting average selling price (ASP) for FY2018 is $785 with annual FY2018 revenues from iPhone of $157 billion. For FY2019, I have assumed a ASP of $860 with annual FY2019 iPhone revenues of $172 billion. The graph below shows my revenue assumptions over FY 2018 and FY2019 across all products.

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The EPS estimates coming out of my model, using the assumptions above (amongst others), for FY2018, FY2019 and FY2020 are $10.17, $11.45 and $11.81 respectively (I agree with the estimates of $9.00 for FY2017). That represents 13% EPS growth for 2018 and 2019, slowing to 3% in 2020. At the current share price of $160, the forward PE (excluding cash) would look as per the graph below.

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My analysis suggests that AAPL either deserves a higher multiple than the recent past to justify its current value or it will have to convince enough new iPhone users to buy its new products to take market share from its competitors and sell more than 200 million iPhone annually for the foreseeable future.

Given the potential headwinds for iPhone 8 and iPhone X over the short term, the current price may be difficult to defend near term as the market gets used to lower iPhone sales at higher prices (and hopefully margins too). Then again, going negative on AAPL hasn’t proven fruitful in the past and the analysts are currently hyping up AAPL’s prospects with price targets heading solidly towards $200.

Given my previous history of questioning AAPL’s valuation, maybe indecision is the best answer for the time being……

Tech Treks

One lesson from the internet bubble is that big is beautiful in tech. But longevity is another lesson, think Yahoo! So one must be fickle in ones tech affections and one must never ever pay too much. After much patience, I was lucky enough to eventually get into Apple in early 2013 when sentiment was particularly sore. I didn’t manage to heed my own advice on getting into Google at a reasonable price in December 2014 when it was trading around 60% of its current value, as per this post on internet relative valuations (more on that post later). Since 2013, I have watched sentiment gyrate on AAPL as the standard graph I use below illustrates (most recent AAPL posts are here and here). I used the current $135 price high as the most recent data point for the Q12017 valuation.

click to enlargeaapl-forward-12-month-pe-ratios-q1-2017

Investors and analysts seem giddy these days about the impact of Trump tax changes and the iPhone 10 year anniversary on AAPL and have been pointing to Berkshire’s position increase in AAPL as confirmation bias of more upside. I, on the other hand, have been taking some of AAPL off the table recently on valuation concerns and will likely again be a buyer when the inevitable worries return along the “one trick iPhone pony” lines. God bless gyrating sentiment! Even Lex in the FT was saying today that the current TTM PE ex net cash of 13 is reasonable (eh, a TTM PE ex net cash of 7 a year ago was more reasonable)! AAPL still has be a core holding in anybody’s portfolio but prudent risk management requires trimming at this price in my opinion.

In my search for new ideas whilst I await some divine sense to emerge from the Trump & Brexit fog, I thought it would be interesting to revisit the post referred above on internet valuations. First off, I took the graph showing forward PEs to projected EPS growth using analyst estimates from December 2014 and inserted the actual change in share price from then to now. Two notable exceptions, at the extremities, from the graph below are Amazon and Twitter with share price changes of 173% and -56% respectively.

click to enlargeinternet-multiples-dec14-as-at-feb17

Although every company is different and has its own dynamics, my simplistic take from the graph below is that high PE stocks (e.g. > 40) with high EPS projections (e.g. > 35%) can easily run aground if the initial high growth phase hits harsh reality. The sweet spot is decent PEs with EPS growth in the 15% to 35% range (again assuming one can get comfortable that the EPS growth projections are real) indicative of the larger established firms still on the growth track (but who have successfully navigated the initial growth phase) .

A similar screen based upon today’s values and analyst estimates out to 2018 is presented below. This screen is not directly comparable with the December 2014 one as it goes out two years rather than one.

click to enlargeinternet-multiples-feb2017

Based upon this graph, Google and Netease again look worthy of investigation with similar profiles to two years ago. Netease has the attraction of a strong growth track record with the obvious Chinese political risk to get over. Expedia looks intriguing given the strong growth projected off a depressed 2016 EPS figure. Ebay and Priceline may also be worth a look purely on valuation although I have a general aversion to retail type stocks so I doubt I’ll bother look too deeply. All of the data used for these graphs is based upon analyst estimates which also need to be validated.

Valuations currently are juicy, generally too juicy for me, so this exercise is simply one to determine who to investigate further for inclusion on a watch-list. Time permitting!

Apple Average

It’s always strange when you have a relief rally in a stock (in after hours at least) because the actual results are not as bad as expected. So it seems to be with AAPL’s Q3 results. iPhone sales were not as bad as expected (albeit the lowest unit iPhone sales in 7 quarters at just above 40 million units) and the current quarter revenue guidance was above expectations. The average revenue per phone was below $600 for the first time in 2 years due to the the latest models with promises of improvements from management in future quarters. When the dust settles on the Q3 results though it could be time to finally reassess AAPL’s future trajectory.

The graph below shows the latest results by product which illustrate just how poor a quarter this was relative to historical trends, with services being the sole bright spot.

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AAPL Revenue by product Q32016

The split by revenue by region again illustrates the challenges AAPL is having in China. It also shows the lackluster response to Apple’s current products in the US.

click to enlargeAAPL Revenue by region Q32016

On valuation, AAPL still looks reasonable on a forward PE excluding cash basis (using analysts estimates for the next 4 quarters), as per the graph below.

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AAPL Forward 12 Month PE Ratio Q32016

The bulls are hyping up the iPhone 7 cycle as a source of future growth which is now the tired but only realistic growth thesis for AAPL. In the medium term however AAPL looks range bound around $100.

Apple below $100

In a market like this one, it’s impossible to tell what is going to happen next. The smell of fear has been in the air with greed cowered by uncertainty. Greed may push back soon with earnings, and particularly guidance, dictating the short term path whilst oil and China, amongst other macro factors, will continue to dominate the overall direction.

Overall I remain cautious on equities with a downward bias. I am sticking to my conviction stocks whilst keeping cash on the sidelines until I find a blatant bargain or two. Notwithstanding that stance, it’s always good to look at your positions and see if some risk management re-weighting is called for. And that’s the reason for a quick look over Apple before its earnings next Tuesday.

Apple is in a hapless position currently and likely has to blow away the December quarter estimates (on the number of iPhones sold, the average price, and the gross margin received) PLUS give a strong March quarter guidance to move up in a meaningful way. Given that a repeat of the outstanding results of last December’s quarter (see post here) compared to current expectations is improbable, I would suggest Apple could trade around or below $100 for a while yet. Analysts, whilst screaming about its valuation, have become increasing negative on the December quarter and guidance for their Q2 quarter. Apple may struggle to come in much above the top end of its guidance of 77.5 million iPhones (it has come in above guidance for 5 consecutive quarters albeit at a steadily reducing level above the top estimate).

The geographic split of revenue, as per the graph below, will also be closely watched to see if China’s economy is impacting Asian growth.

click to enlargeAAPL Revenue by region Q42015

Despite its best efforts, Apple remains primarily a phone company with last year’s iPhone revenues making up two-thirds of the total, as per the graph below (with my estimates for Q1).

click to enlargeAAPL Revenue by product Q42015

I played with some estimates to stress the view on an AAPL valuation below $100. Taking a jaundice view of adjusting average analyst non-GAAP estimates for 2016 and 2017 plus some pessimistic estimates of my own on 2016 and 2017 (with iPhone slowing to sales of 220 million and 200 million compared to around 230 million for 2015), I estimated the forward PEs, excluding net cash (currently around $150 billion), as per the graph below (based upon diluted GAAP EPS, not the adjusted EPS analysts love) using tonight’s close of $96.30. The multiples are quarterly point estimates using the share price one month after the quarter’s end.

click to enlargeAAPL Forward 12 Month PE Ratios Q4 2015

The graph above clearly shows the swings in sentiment on Apple over recent years as the market grapples with the future demand for the iPhone after each upgrade cycle. Tuesday will indicate whether the current concerns about iPhone sales and margins peaking are justified. Other concerns, such as a possible $8 billion tax bill from the EU, pale in comparison to those iPhone concerns. Notwithstanding these real concerns, forward multiples of below 8 look too low to me given Apple’s operating record (unless you buy into the Apple could be the next Nokia thesis which I don’t).

By way of a comparison, my estimate for a similar graph for Google is below (again using diluted GAAP EPS). Google will be another stock where earnings for Q4 will be very interesting as they split out their figures in line with the new Alphabet structure and (maybe) demonstrate again their new emphasis on cost control. Expectations look high based upon its current valuation.

click to enlargeGoogle Forward 12 Month PE Ratios Q4 2015

The comparison does reflect positively on Apple’s current valuation multiple and I’m happy to hold the AAPL position I have. A key outcome from the AAPL earnings call will be if Cook can provide sufficient catalysts for Apple’s value to trade significantly above $100.

As always, time will tell.

 

Follow-0n Evening 26th after earnings: Over the next few days and weeks, I’m sure the chatter about Apple and the iPhone will likely get over-bearing. The delicately posed share price of $99.99 before earnings will come under pressure. Q1 revenues were at the lower range of expectations and Q2 guidance at $50-$53 billion is weaker than expected. China revenues showed slowing growth. On the positive side, the average revenue per iPhone in Q1 was higher than expected and operating margins were strong. I revised down my estimates for AAPL’s 2016 and 2017 diluted EPS (to $9.15 and $8.60) and iPhone sales to 210 million and 190 million. The revised revenue splits and forward PE multiples (at share price of $99.99) are shown below. Thesis, as per post above, on AAPL’s valuation remains basically unchanged although the share price see some selling pressure in the short term.

click to enlargeAAPL Revenue by region Q12016

click to enlargeAAPL Revenue by product Q12016

click to enlargeAAPL Forward 12 Month PE Ratios Q1 2016.png