Apple (AAPL) stock has been punished by investors after the company’s profits fell in the most recent quarter despite increasing revenues. Apple has been under massive pressure since its last earnings report when management indicated that the company will fail to grow at the stupendous rates of the past. But that should have been obvious to anybody given that Apple is clocking almost $40 billion in revenues each quarter. The company is already the biggest technology in the world and expecting it to grow like a startup is quite stupid in my view.
I had advocated a short position when the stock was trading near its all time high above $700. At that time, the market had become overly bullish about the Apple story and analysts were making crazy projections. Apple going to $1000 reminded me of “market gurus” making predictions of the Dow reaching 36,000 during the dot com boom.
I had turned bullish after the stock crashed by ~35% after its CQ412 results. The stock has declined by around ~6% since then and I see no reason to change my stance. The actions initiated by Apple management show that they are concerned about stockholders . The biggest share buyback program in history is going to start soon and will provide a very solid floor to the stock price. Stockholders have very little to lose in the next couple of years as Apple will be one of the biggest stock buyers. The company also hinted that exciting new products will be launched in the 2nd half of the year and 2014. While the Q2 guidance did not exactly set the market afire, ~$35 billion in revenues with a gross margin in excess of 35% is nothing to scoff at. The market is totally neglecting the possibility that the new products can be a success. The valuation has become quite cheap and I would look to start a position in Apple.
1. Dividend yield – Apple has been heavily criticized for hoarding the biggest cash pile in history as the company generated tremendous amounts of free cash flow every quarter. The company has grown exponentially in the last decade creating massive markets through sheer innovation. The company management has not been deaf to the criticism and decided to increase its dividends by 15%. Apple stock will give a dividend yield of ~3% at the current stock price.
2. Biggest share buyback program in history – Along with the increased dividend, Apple will also increase the size of its share buyback program to $60 billion. At the current stock price, Apple will decrease its total share count by ~15% in the next couple of years. To avoid US taxation, Apple will take on debt to fund its gigantic buyback program.
So today, we are announcing an aggressive plan that more than doubles the size of the capital return program we announced last year to a total of $100 billion by the end of calendar year 2015. The vast majority of our incremental cash return will be in the form of share repurchases. As the Board and management team deliberated among the various alternatives to returning cash, we concluded that investing in Apple was the best.
In addition to the share repurchases, we are increasing our current dividend by 15% to further appeal to investors seeking yield.
3. Cheap valuation – Apple trades at a very cheap valuation and has a forward P/E of ~5x if you subtract its huge cash hoard. The probability that Apple will succeed with its new products like the Apple TV, cheap iPhone, iWatch etc. is being given a zero value in my view.
4. Tablet Leader – Apple continues to be the undisputed leader in the tablet market with a global market share of more than 50%. Even as competitors rush to imitate Apple by bringing out copycat products, Apple is already selling more than 15 million tablets each quarter. Apple’s ability to bring out stunning new products and create a massive new global market from nothing is truly amazing. iPad sales increased by a stunning 65% year on year as the company is enjoying the explosive growth in a market it single handedly created. Tablets are expected to grow by more than 50% for the next two to three years
Turning to iPad, we were thrilled to sell 19.5 million iPads during the quarter compared to 11.8 million in the year ago quarter, that’s an increase of 7.7 million units or 65%.
5. Mac lineup grows faster than the market – Apple has created a premium niche in the commoditized PC and laptop market through its high end Macintosh laptops and desktops. Though Mac sales declined by 2% in this quarter, it was much better than the overall PC industry which saw a 14% decline in shipments.
6. Apple’s store is killing it in app sales – There are many more Android products in the world right now than iOS products. But the majority of the profits from selling apps go to Apple as the company caters to the high end of the market. Apple has crossed the $4 billion mark for sales from its software and services division. This is a stunning achievement that is being ignored by the market. For comparison, Microsoft sells ~$5-6 billion of Windows licenses every quarter.
Today, our iTunes store offer the broadest combination of geographic reach in content depth in the industry, and they surpassed quarterly billings of $4 billion for the first time ever in the March quarter, that’s a $16 billion annual run rate making our digital content stores the largest in the world.
Data – Canalys
7. New Product Cycle to be unleashed later this year –The raft of flagship smartphone launches by competitors has raised investor expectations that Apple will also accelerate the launch of its new products. However, if you look at Samsung’s new Galaxy S4, the product does not have anything much to distinguish itself from S3. In fact, early reviewers are giving S4 thumbs down and advising that buyers should opt for a cheaper S3.
8. Presence across all major consumer products – Apple has a dominant presence across all major product categories having pioneered some these segments. While the iPhone 5 was not a game changer as expected, the earlier versions of the iPhone are still selling quite well. Apple has a large market share in the US smartphone market and the company seems poised to increase its market share in China and India as well. The company also sells most of the tablets being sold globally having created this category with the launch of the iPad. The company also is increasing its market share in the PC market with its Macintosh range of laptops and PCs.
9. Sentiment is highly negative now – The sentiment towards Apple has been extremely bearish in the last six months. The company has shown no signs of being complacent or lazy. In fact, it has shown a remarkably smart distribution and pricing strategy by pushing the iPhone 4 in emerging markets. Apple has saturated the developed markets with its products. The company cannot sell its premium products in poor countries like India and China where most consumers don’t have the income to purchase iPhone 5. Apple has become the No.2 smartphone seller in the Indian market in just one quarter and it is expected that Apple will double its sales in the Indian market to $1 billion.
10. Massive Free Cash Flows and the world’s biggest cash hoard – Apple is generating almost $10 billion in FCF every quarter and has got more than $140 billion of cash on its balance sheet. Even after returning more than $100 billion to its shareholders, Apple will still have the world’s biggest cash pile.
11. Enterprise Technology Market – Apple is making rapid inroads into the enterprise technology space with Tim Cook saying that Apple is seeing increasing adoption by enterprises. The BYOD concept will help Apple more than other technology companies as its “walled garden” approach gives it an edge over the Android ecosystem.
Businesses around the world continue to scale iPhone across their workforces. Globally, nearly 30,000 companies are developing and distributing iOS apps for corporate use by their employees. Cisco’s Bring Your Own Device program across 80 countries has resulted in a 50% increase in the number of iPhones connecting to its corporate network in the past year.
12. Tablet and Smartphone markets are growing rapidly – Both smartphones and tablets are growing at a tremendous rate with smartphones outselling features phones for the first time in history. Unlike PCs, tablets and smartphones have a much shorter replacement cycle which helps keep their growth rate high. Tablet sales will triple over by 2016 while smartphone sales should double to more than 1.4 billion units. Even if Apple maintains its current market share in smartphones it will see its phone shipments double during this period.
Take the smartphone market for example, IDC estimates that this market will double between 2012 and 2016 to an incredible 1.4 billion units annually, and Gartner estimates that the tablet market is growing at an even faster rate from 125 million units in 2012 to a projected 375 million by 2016.
13. Customer satisfaction and loyalty – Apple has very high customer satisfaction numbers due to the tight integration of its hardware and software. The company never compromises on the quality of its products which allows it to charge a substantial premium over its competitors.
A recent study by Kantar measured 95% loyalty rate among iPhone owners, substantially higher than the competition, and iPhone remains top in customer experience. Last month, we were very pleased to receive the number one ranking in smartphone customer satisfaction from J.D. Power and Associates for the ninth consecutive time. The most recent survey published by Change Wave indicated a 96% satisfaction rate among iPad customers.
Summary
Every company in the world faces risks in the form of competition, technology obsolescence, manufacturing problems etc. Our work as investors is to find out stocks where the risks have been adequately discounted. The sentiment towards Apple remains heavily bearish despite the company making shareholder friendly moves. The company is not killing itself by introducing a new flagship product every quarter which does not improve much over the previous products. Apple’s ecosystem remains one of its biggest underappreciated strengths. Apple’s stock will get a boost as new products are introduced later this year which will generate buzz around the stock. Till then, I would remain happy to take the 3% dividend yield. I have no doubt that Apple will remain a leader in the smartphone and tablet industry in the next few years. During that time, tablet shipments should triple while smartphone sales will double. I think that Apple will see decent growth as the sales in its core markets keep growing strongly.