Bittersweet Apple

Apple (AAPL) is always in the news. Today it is in anticipation of the iPhone 7.

The narrative is either “its going gangbusters” or “its going down the toilet”. Right now, we seem to be closer to the latter.

But let’s distance ourselves from this noise, and assess the facts.

Apple is insanely profitable. It consistently boasts of operating margins in the 25-35% range and ROE in the 30-40% range. When you compare those numbers to its cost of capital (~10%), you begin to understand why it makes net profits of $40-50B/year on revenues north of $200B.

Apple is a well-managed company. Tim Cook is not Steve Jobs. And that is a good thing. Cook seems to have opinions that are less brash, and more considered (it is possible that iPhone6/6+ may have not happened under Steve Jobs). Their capital management strategy has evolved; gone is their allergic reaction to debt. Currently AAPL, sports a debt/capital ratio of about 1/3, which seems quite prudent. It has also been returning capital to shareholders via dividends and substantial buybacks.

Apple is a growing company*. From 2011-2016, revenues have more than doubled from $108B to $220B. In the same period, EPS has grown from $3.95 to $8.30 (estimated for 2016). Sure, numbers have come down a tad from 2015, but that tells you more about the explosive demand that a larger iPhone and a large market (China) unleashed a year ago.

Apple is still reasonably cheap. I took Damodaran’s worksheet from earlier this year, plugged in TTM numbers (its been two quarters since that update). No matter what I did, I couldn’t come up with estimates of value below the current market price. Most reasonable and conservative estimates for inputs (in my opinion) led to a value of $115-$125.

Valuation

One doesn’t have to do an explicit DCF, with all its bells and whistles, to figure out a reasonable value.

The EPS last year was $9.22. That was a blockbuster year. This year estimates are for an EPS of $8.30. Let us suppose that normalized earnings are $8.50 (this is arbitrary – but seems reasonable). Given’s AAPL’s cost of capital (under 10%), an appropriate PE multiple may be 10x-12x. This would suggest about $85-$100/share of value supported by earnings.

Then there is the excess cash. Currently AAPL has about $42/share of cash, and $12/share of total debt for a net $30/share of cash. Since much of the cash is trapped overseas, we can apply a 20% haircut, and estimate net cash at $24/share.

This gives us a no-growth valuation of $110-$125/share. Not very different from the DCF.

Historically, AAPL’s stock price has traded between 9x-18x TTM EPS, as market sentiment has waxed and waned. At an EPS of $8.50, this would suggest a wide $75-$150 band, with a mean between $113/share.

At its current share price near $110, AAPL is fairly priced under a no-growth assumption.

Valuation Notes

  • If AAPL can grow earnings, it will be worth more. The Services segment has annual revenues of $24B. While this is less than 15% of Apple’s total revenue, this segment is growing at a brisk 20% clip. It is useful to compare this $24B number to Microsoft and Google’s total revenue, which is around $80-90B/year.
  • Can AAPL shrink? Revenues could fall, and/or profit margins may become challenged. AAPL’s primary value driver is the iPhone (>50% of revenues and income). If the iPhone is threatened, Apple is threatened. In a subsequent post, I will try to collect my thoughts on why I think the iPhone may be more durable than one might think. But right now, sure, if the iPhone business dies tomorrow, AAPL would be worth less than half of what it currently is.
  • At current prices of ~$110 a pop, it is a less compelling buy then when it was trading in the low-$90 range, no so long ago. Considering Apple is so large it is quite amusing to watch it fluctuate nearly ~30% nearly every year.
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