Tag Archives: average selling price

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.

Appletastic

Investing can be cruel. Every now and again I find it useful to look back at my investment decisions and try to learn from mistakes. At the beginning of his year, I was knocked sideways about the profit warning from Apple (AAPL) and exited one of my favourite stocks, and one of the most profitable over the previous 5 years, as per this post. If I had ignored all the negative news such as China worries or the implication of the dropping of the iPhone unit disclosures, and blindly held faith, I would have been rewarded by an increase of approximately 77% in the stock since the date of that post! Just shows how clueless this bogger is, dear reader!

In my defence, the graph below of the actual results for FY2019 illustrate how the issues that confronted AAPL at that time played out (more on the estimates for 2020 later).

click to enlarge

As can be seen clearly by the 12-month trailing revenue split, AAPL’s iPhone revenue plateaued in Q4 2018 and went into decline over FY2019 due to the failure of its strategy to push average iPhone prices higher. Even AAPL discovered that it is not immune to price elasticity. With the introduction of the iPhone 11 and the planned iPhone SE2, AAPL has now reverted its strategy back towards an ASP for the iPhone below $700 whilst it harvests its massive installed base for services. New cheaper handsets and the possibility of a new 5G super-cycle in 2020 has meant that AAPL is once again a market darling. Taking some of the current analyst projections for 2020 and the bullish Q1 2020 guidance from AAPL, I revised my 2020 estimates as below (I, like everybody else, must make my own estimates of handset unit sales each quarter).

click to enlarge

In terms of valuation, if I stick with my trusted AAPL valuation methodology of the forward PE excluding cash ratio analysis, using my EPS estimates for 2020, the stock is currently trading around a 17 PE, approximately 75% above the 10-year average! If I revert to the bull thesis (held before the meltdown late last year) that the market has recognised that AAPL is not purely a hardware firm any longer and deserves a hybrid hardware/software rating to reflect its growing services business, the current price is approximately 30% above the fitted trend line (as a proxy for the hybrid valuation), as below. I will have to come up with a better hybrid valuation methodology in the future but it’ll do for now (all ideas welcome on that front!).

click to enlarge

So, the bottom line is that AAPL is richly priced currently but waiting for a perfect entry point may be a mugs game for such a quality firm with the possibility of a new iPhone cycle just beginning. AAPL has yet again shown how it can adapt and change course when its strategy is clearly not working. Still, I’ll be a mug for a while longer to see how this market and overall valuations develop (there will likely be a host of upgrades for AAPL in the coming weeks). I do admit to missing having AAPL in my portfolio, so I will likely not wait too long before establishing an initial position again. If any of the hype around 5G becomes reality as 2020 develops, I can see AAPL being a big benefactor next year.

Apple Crush

The news just keeps getting worse for Apple (AAPL) with all the negative rumours being confirmed by the top-line warning announced last night. In my last post on AAPL, I ruminated that the stock could fall as low as $160. Well, it was trading below that figure prior to last night’s warning and it looks set to possibly test $140 today. The only bright side of the announcement is that it quantifies the bad news which is the first step towards reaching a bottom. The enviable round of analyst downgrades means the next few weeks will likely be choppy for both AAPL and the market.

In the interim, I quickly revised some numbers in my model, as below.

click to enlarge

Based upon my historical forward multiples excluding cash, whilst reverting to a straight average multiple of 9 compared to an increasing multiple (that was in another era now!), my new estimate of how low AAPL can go is $115 per share, a near 30% drop from last night’s close.

click to enlarge

Whether I will be a buyer around the $120 level will depend upon what the overall market is doing. Best to wait on the side-lines for this drama to unfold.

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.

click to enlarge

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.

click to enlarge

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.

click to enlarge

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.

click to enlarge

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.

click to enlarge

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).

click to enlarge

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.

click to enlarge

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.

click to enlarge

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……