Wall Street is a curious place.
Last summer when
(ticker: AAPL) shares soared, analysts kept raising their price targets to higher and higher levels. This week after the company dropped a guidance bombshell, many of the same analysts slashed their forecasts. The Street’s reactive stance does little to help retail investors who watched Apple lose $75 billion in market value on Thursday before they could even think of hitting the sell button.
In the end, investors are better off holding on anyway. While Apple’s stock performance is currently tied to iPhone sales, its future is tied to a lucrative installed base that’s estimated to be 1.3 billion devices. CEO Tim Cook needs to find a better way to monetize that base with more services revenue. The latest slip-up is sure to accelerate those efforts.
In lowering Apple’s December-quarter revenue guidance to “approximately $84 billion”—versus the Wall Street consensus of $91.3 billion—Cook largely blamed China. “While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China,” he wrote in a letter on Wednesday.
The company also provided a litany of other reasons such as iPhone battery replacements, lower carrier subsidies, and currency movements, but didn’t touch upon the most obvious one—Apple flubbed the product cycle, meaning the features on its models released last fall weren’t compelling enough.
When asked for comment, an Apple spokesperson said the company had nothing to add beyond its announcement.
New Street Research analyst Pierre Ferragu, who issued a prescient Sell rating on Apple in August, estimates that 80% of the guidance miss was due to a lower level of upgrades with the rest due to China issues. In November, he told Barron’s that sales of the iPhone XR were performing poorly. “iPhone users love their phones so much that they stick to them longer,” he wrote in an email on Thursday.
Customer loyalty remains the good news. On Thursday, Ferragu raised his rating on Apple shares to Neutral, saying he no longer sees reasons for Apple to underperform.
Every few years, investor sentiment on Apple swings from extreme pessimism to extreme optimism: from the disappointment of the iPhone 5C, to the massive success of the large-screen iPhone 6, to the underperforming iPhone 6S.
Another mediocre product cycle doesn’t change Apple’s attributes: a bulletproof balance sheet, a stellar brand, a loyal customer base, and a sticky ecosystem of software and services. iPhone users are still likely to upgrade to another iOS device due to its high levels of customer satisfaction.
Apple shares now trade for 12 times projected fiscal-2019 earnings per share of $12.24, compared with 14.2 times for the S&P 500. The smartphone maker’s stock averaged a forward earnings multiple of 13.6 over the past five years, according to Bernstein. Apple is even cheaper when taking account of its $130 billion net cash position. The forward P/E ratio is about 10 when Apple’s net cash is stripped out.
Barron’s has covered Apple’s ups and downs over the past two years. At year-end of 2017, we predicted Apple’s market value could rise to $1 trillion in 2018. It reached that milestone in August.
Then, in November, we suggested that Apple stock could fall about 15% to $165 as the weak iPhone product cycle became increasingly evident. Apple shares hit $165 a month later. We said that was a good entry point, even with a bumpy ride still to come. Our latest call was a bit early, with the stock now trading at $148.26.
Our primary argument was that investors should wait until the lackluster iPhone product cycle was fully incorporated in Wall Street models. Sure enough, following Apple’s uncharacteristic guidance cut on Wednesday evening, Wall Street has now lowered its expectations to an 11% drop in iPhone units for fiscal 2019. That means the compelling entry point we predicted has arrived.
Marcelo Lima, a hedge-fund manager at Heller House, tells Barron’s that while the company has recently fallen behind its competitors in some technologies, the stock market is too pessimistic over Apple at its current valuation.
Apple’s “earnings multiple is implying no growth. That’s too draconian,” he writes in an email. “I think Apple will continue to innovate and give consumers reasons to buy new iPhones in the future.”
Another key difference from prior down cycles is that Apple is more committed to a shareholder return that could support its stock price. Cook this week reaffirmed Apple’s goal to be “net-cash neutral” over time, basically hinting at larger share buybacks or dividends.
“The new guidance resets the bar and the bad news is now out of the way,” RBC Capital Markets analyst Amit Daryanani told Barron’s. “Apple, with its strong balance sheet and aggressive buyback, remains a core large-cap tech holding.”
The analyst said that Apple can generate earnings growth of 10% even if iPhone sales flatline in coming years. That’s a reminder that Apple’s bottom line is still benefiting from its profitable services segment, along with continuing buybacks.
There’s also the real possibility that Apple could revitalize iPhone sales, resuming Apple’s growth characteristics.
Perhaps Apple will launch a better lineup later in 2019. But it’s more likely that a wave of fifth-generation wireless technology, or 5G, could drive an iPhone revival. That’s probably a 2020 or 2021 story, but investors could begin recognizing the opportunity sooner, much as they did in the year leading up to the 2014-release of the iPhone 6, when Apple finally delivered a larger-size model.
With Apple’s stock down, there are multiple ways to win. The stock now yields a generous 2%. Assuming Apple’s multiple returns to its 13.6 average, the stock is worth $166.46. Add back $27 in net cash per share—a logical step given that Apple has finally promised to bring its cash position to zero—and Apple is worth $194, 31% above its latest close.
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