On Friday’s Fast Money program on CNBC, Tim Seymour answered viewer question with his thoughts on Apple (AAPL). I rudely interrupted Tim almost right off the bat when he mentioned valuation as justification to own the shares. Watch here:
Tim has been long the stock for months, if not quarters, and has been right on the story, and obviously the stock. I guess where Tim and I disagree is that cheap valuation as the intial input to continue to justify holding the stock (I am sure he has other reasons). AAPL currently trades well below a market multiple at 14x expected 2015 earnings, excluding $194 billion in cash on the balance sheet (26% of their $732 billion market cap, 20% net of $44 billion in debt), AAPL trades a little less than 11x. I am not going to use this post to debate whether or not the stock deserves to trade at a discount, or why it does. But it does.
The point I was making in the clip above is simple. AAPL has seen a massive acceleration in earnings and sales with the launch of their larger iPhones last fall. In the current fiscal year, AAPL’s earnings are expected to grow 40% year over year, on 27% sales growth to $232 billion!! Next year as the iPhone 6 upgrade cycle moderates Wall Street analysts have modeled for earnings and sales growth to also moderate to about 7% year over year. So if the stock was trading well below a market multiple in a hyper growth phase, I am not sure why one would expect to see multiple expansion in a period of decelerating growth?
There is definitely the possibility that Wall Street consensus is too conservative for fiscal 2016 estimates, with few expecting large contributions from Watch, Pay and their impending Music launch, but I suspect that is for good reason, they are not likely to move the needle individually next year, or for that matter combined. Apple is the iPhone company getting more than 70% of their annual sales from iOS devices. Could growth in regions like China outperform and offer unforeseen upside? Sure, but I suspect that is one potential outcome that consensus estimates incorporate.
In my mind one of the main risks to owning AAPL here is the potential for growth in China to moderate, the flattening out of the iPhone upgrade cycle, disappointment on new products not filling in the cracks, which could lead to a massive sentiment shift from a fairly universal bullishness, similar to the turn following the launch of the iPhone 5 in September 2012, their last intro of new larger phones. I would also add that while the iPhone 6 numbers have been HUGE, the pent up demand had little to do with some new-fangled technology, but merely larger device sizes, and broader geographic distribution. I suspect the launch of the iPhone 6s in the fall should have less of an impact on consumer purchasing decisions.
Taking a quick look back, AAPL saw earnings grow 60% in fiscal 2012, with 45% sales growth. In fiscal 2013 earnings declined 10% year over year, on 9% sales growth, as gross margins declined 6% from their fiscal 2012 peak, and the stock declined 45% peak to trough (Sept 2012 to June 2013). Since those lows two years ago, AAPL has rallied 125%, but gross margins have remained below the peak, expected to be 40% this year.
So what will fiscal 2016 bring for AAPL?
I suspect analysts have it right with significantly moderating growth. So unless you know something that I don’t, which could only be a new blockbuster product out of Cupertino, or a path to higher margins, I am not sure why it makes any sense to expect multiple expansion in one of the most widely loved stocks, and the largest market value the world has ever seen.
Oh, and on purely a technical basis, the stock is having a hard time establishing new highs, holding on for dear life to its 2% Q2 to date gains, with $120 a logical technical support level:
Most of the stock’s 15% ytd gains obviously came in Q1, and I guess what’s important to note is what appears to be waning momentum, the stock’s inability to confirm multiple new highs in the S&P 500 and the Nasdaq Composite, each of which it is the largest single component. All that said, the stock is fine (for now) in my mind, as long as it holds the uptrend that has been in place since last April:
So from where I sit, valuation should not be the main reason to own AAPL. Map out how growth can re-accelerate, and profitability remain stable/increase. Yeah, yeah, they buyback their stock hand over fist, and iOS market share is stable, but as interest rates rise their cost to fund buybacks/dividends will also increase as most of their cash is overseas. I think it is safe to say that the stock is far from a No-Brainer at current levels, based on what we know about current products and their runway. It may not be a short here but it could be dead money for the time being.
DISCLOSURE: I have no position in AAPL stock or options. I am long 2 dozen Apple products accumulated over the last 5 years (business and personal), and a very happy customer.