Interactive Investor

Stockwatch: Apple poised to surprise again on the upside

7th November 2017 09:02

Edmond Jackson from interactive investor

At an all-time high of $172.50, is consumer electronics giant Apple still a stock that British investors should consider, or a US bull market leader exposed? 

Long/short controversy is nothing new: when I first drew attention in August 2013 at $71 equivalent (£54, before a 7 for 1 stock split), opinion was divided between analyst fans extolling long-term potential of the technology and sceptics who argued too much depended on the iPhone and Apple was already missing expectations. 

Yet, a price/earnings (PE) multiple in the low teens priced this in, and a $150 billion cash pile underwrote both dividends and innovation.  I tilted to bullishness because the situation enabled management to "make its own luck" versus a negative bias in sentiment.  Assuming the technology could wow consumers over the long run was speculative, but a hard-nosed investor like Carl Icahn's move to accumulate $4.4 billion worth of shares from 2013 underlined financial value.

Icahn then pushed Apple to pay more dividends and buy back stock, generating useful returns over a four-year holding period as the price rose overall.  By end-April 2016 he had sold out, he said because China could make it very difficult to sell there – which is true in terms of domestic competition in a major expanding market – although as an activist investor he may have felt he'd well exploited a value gap and it was time to deploy capital to fresh targets.

Latest quarterly results affirm a growth rating

Apple's trailing 12-month PE multiple is currently 19.6 versus an average 23.75 for the Nasdaq index, up from about 13 times four years ago.  As an $885 billion company it therefore needs to deliver more exciting earnings growth than an overall flat trend in the last two years, earnings per share (EPS) having re-rated about 50% from 2013 to 2015.  

This is challenging arithmetically for a company of such scale, unless Apple can re-create a "must-have" culture with compelling products.  Media coverage for iPhone 8 and 8 Plus sales was initially weak: hardly any queuing around the 22 September launch date.

Yet Apple's Q4 results (Q3 calendar 2017) released on 2 November show EPS jumping 24% to $2.07 on sales up 12% to $52.6 billion, versus consensus for $1.87 EPS on $50.8 billion sales.  The iPhone 8 and 8 Plus have proved Apple's best-selling products at launch, although iPhone-related revenue rose only 2% like-for-like to $28.85 billion, representing nearly 55% of total revenue for that quarter. 

It's followed by "services" such as the App Store, iCloud and Apple Music, which represent 16% of group sales, but are rising strongly up 34% to $8.5 billion.  This revenue is expected to double in the next four years, benefiting from tying customers into the Apple universe where profitable add-ons can be introduced. 

The Apple Mac computer weighs in at number three with revenue up 25% near $7.2 billion to represent 14% of sales – very good progress considering Apple PC's get criticised for being expensive and incorporating old technology.  This December, the launch of the iMac Pro is expected to address such, albeit with a circa $5,000 price tag.  It does however show innovation bearing fruit in line with my thesis (admittedly) four years ago.  Other products include the iPad tablets, Apple Watch, Beats headphones and Apple TV set-top box – which have seen new versions launched in 2017. 

Sales are guided higher for the current quarter, which should benefit from the launch of the iPhone X; this given before a surge in demand that's been reported with Apple fans forming long queues to the stores, globally. 

Cult revival of Apple products as status symbols?

A bull case is this early sign of hysteria on streets re-affirming excitement about owning the iPhone as a technology and status symbol – which then spreads to buying other Apple products as you get tied into the universe.  Social psychologists may draw a link with a seemingly global epidemic in narcissism, fuelled by things like social media for which a smartphone is ideal, the iPhone also conveying a personal sense of perfection. 

All this still needs proving in the next quarterly figures at end-January 2018: will iPhone sales growth soar into double-digits?  The stock explores a record high significantly as it senses potential for another "beat" linked to Christmas sales.    

Mind that, while the iPhone X is expected to sell well in China, its targeting a limited range of customers with a price tag near $1,300 means it can't reverse the loss of market share to aggressive Chinese rivals – the iPhone and Apple's revenues suffering six consecutive quarters of declining sales in China.  Domestic manufacturers are dominating the market, especially for younger customers, in the $300 to $500 zone.

So, if you believe the wider US market is on firm enough foundations, then Apple is a trading "buy" despite the challenge to define a target until sales to Christmas are known.

US tax reform could also make – or break - the rally  

Another reason for all-time highs is froth as interest rates appear set to remain low under Jerome Powell, the new choice as Fed governor.  The extent of capital pouring into mutual/index funds means Apple shares inevitably get bought as the largest US company. 

Secondly, a cut in the statutory corporate tax rate to 20% as promised by President Trump would not only lift Apple's profits, but create a windfall of cash parked overseas that could be applied for expansion, innovation and greater returns of capital to shareholders.  

Mind, that Apple shares have anyway risen over 50% since the US presidential election a year ago; also the tax reform bill can still run into trouble in the Senate especially, given a required $1.5 trillion increase in the US budget deficit and raising the debt ceiling. 

It's potentially the chief disruptor of US stocks with Apple a prime leader.  So, if expectations sour on tax reform then traders are likely to short-sell market leaders, such as Apple, to benefit.

Apple Inc - Product Summary        
         
 Q3 2017Q2 2017Q3 2016Year on Year
 UnitsRevenueUnitsRevenueUnitsRevenueUnitsRevenue
  $ $ $  
iPhone41,02624,84650,76333,24940,39924,0482%3%
iPad11,4244,9698,9223,8899,9504,87615%2%
Mac4,2925,5924,1995,8444,2525,2391%7%
Services 7,266 7,041 5,976 22%
Other Products 2,735 2,873 2,219 23%
         
Total Apple $45,408 $52,896 $42,358 7%

Long/short status therefore still applies

The win/win scenario, therefore, is strong Q1 (i.e. Christmas) revenues boosted by compelling new products, and a degree of compromise on US tax reform that leaves US companies net-empowered, with Apple a prime beneficiary.  There is already talk of Apple becoming a $1 trillion company on tax reform alone, putting a target on the stock near $200.  

My feeling is Apple is now poised to surprise again on the upside, albeit the expectations for US tax reform are fiscally unrealistic.  Thus, I'm making a positive call on Apple as a medium-term "buy" with a caveat about US tax.  A drop linked to hopes dashed would create an even better buying opportunity if sales then prove strong. So, it's time to be more vigilant of this most internationally traded of US stocks.  

There's no way Apple is likely to cut its dividend – its cash hoard is matched by only 12 companies' capitalisations in the S&P 500 index, so if earnings cover slips below the present circa three times that's no problem, and a measure of progress on tax reform could still boost returns.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

Details of all recommendations issued by ii during the previous 12-month period can be found here.

ii adheres to a strict code of conduct.  Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.

In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.