“Should I Buy Apple Stock?”

Hey friends,

Giving everyone an update into the latest happenings of my life:

• I’ve completed GIM batch 3 together with Jonathan Ang.
• Our GIM community will be exploring stocks listed on the Australian Stock Market, we should be able to conclude in 3 to 4 weeks.
• For the members, it is important to know what are bad companies so that we can appreciate what are good companies.

On my learning side, I purchased two books from Amazon, they are Quality Investing, Culture Code and Value Migration. Over the years, I’ve compiled my recommended book list, you can view it over here. I met up with several fund managers for networking purposes. I’m always learning from their years of experience, it was great to remain in touch.

Now, let’s move on to today’s article. “Should I Buy Apple Stock?”

This is one of the top questions I received from all of you.

Apple (AAPL), one of Buffett’s core portfolio stock, fell 34% from its peak. Many investors are seeing Apple as a dominant player with great franchise value. The brand is recognisable and its wider ecosystem of Apple Pay, iTunes store, App Store and iCloud (services) are taking off.

Source: Credit Suisse

On 2 January 2019, Tim Cook released a letter highlighting downward guidance for Apple’s 2019 Q1.

Source: Apple

I re-created the numbers from Tim Cook’s numbers and measured it against the corresponding Q1 in the previous year. The operating profit is likely to drop by 11.6%. This is not the first time Apple faces a potential drop in their core earnings. Back in 2016, similar things occurred.

Some reasons why I think Apple is facing a drop in revenue:

• The mass customers are not receptive to the price points of newer iPhone models.
• As the technology advancement slows down, the replacement cycle of iPhone is longer.
• The shift away from Apple brands towards Huawei or Oppo phones for Chinese consumers. There is also a consumer boycott given the trade war issues between China and the United States.

Major suppliers such as TSMC, Nidec, AMS, Lumentum have reduced their earnings forecast.

Some of the comments included:

“We saw big slumps in November and December. Orders, sales and shipments in all business segments around the world saw major shifts.” 

“A sudden drop in sales of high-end smartphones.”

Segments

For product:

For geography:

The 5 years compounded growth rates for Americas, Europe, Greater China, Japan, Rest of Asia Pacific were 7.8%, 8.8%, 14%, 9.5% and 7.7%.

If we look at its operating profit before tax and HQ costs, China is contributing 21.9%. This highlights the importance of China as part of Apple’s growth strategy.

China Issues

source: Strategy Analytics

According to Strategy Analytics, for the year 2018, the shipments dropped by 6.8%. For the most recent Q4 2018, the shipments dropped by 22.1%. 

Matthew Brennan from China Channel released a fantastic note on why Apple’s services may not succeed in China, click it out here.

Financials of Apple

Over the years, Apple achieved high margins on both gross and operating levels. It was able to stretch its payable days over time and it created negative cash conversion cycle days. This means Apple’s suppliers are funding Apple’s business.

Apple received the goods, sold the finished goods, then paid its suppliers.

Great ROIC and it is not CapEx intensive.

Valuations of Apple

If we used Enterprise Value over Free Cash Flow, it is selling at an undemanding price multiple of 9.22x. It hasn’t traded that low in recent years.

Even if the free cash flow falls by 20% due to China fears, the EV/FCF would be 11.52x.

It’s not expensive.

Just some thoughts, if I estimated the future free cash flow to be 51.3b. Looking at the past track record, approximately 20% will be used for dividends and the rest is for share buy-backs.

Apple will do buybacks at the run-rate of 41b. Taking 41b divided by current market cap of 722b, Apple would be buying back 5.7% of itself every year. It will increase earnings by 6% every year when share buybacks are conducted.

My Thoughts

Generally, I like companies with growing/widening moats and growth in the bottom line.

While Apple may be cheap, and one can play the valuation multiple gaps, I still feel there are some risks if AAPL continues to suffer in China which I am unable to foresee. While I recognise AAPL is doing other initiatives, but I find the competition is intensifying for iPhone. There are phones that compete with iPhone with comparable specifications and lower price points.

When I chatted with some of my friends, it is clear that Tim Cook is a great executive but he is not a visionary/innovator. He is a great capital allocator. But innovation and products are what makes a company strong, I do not see any new initiatives in this front.

Let’s apply a reasonable price multiple on Apple to be 15x or more, the upside could be 30% or more from here. Apple could be worth >$200 per share. 

My question is how long can Apple grow? It earned 265.6b in FY2018 and it has a market capitalisation of 722b currently. Can it be a multibagger?

Our time should be spent on companies that we can keep for >4 years and beyond.

That being said, I think there are some obvious gains to be made.

References: 

Click to access Q4-18-Data-Summary.pdf

https://news.strategyanalytics.com/press-release/devices/strategy-analytics-china-smartphone-shipments-fell-11-percent-q4-2018