AAPL - Apple Inc.

[Viking]

In a world of slowing iPhone unit sales I expect Apple to continue to find solutions to go upmarket. The 'plus' launch in September of 2014 is one example. The changes to memory, also in September 2014, is a second example. If Apple can continue to increase average selling price per unit for iPhone then Apple can continue to grow total revenue and total profit even if sales are flat.

 

Johnny, I think you are on to something regarding iPad. iPhone has been successful because of iOS; Mac has been successful because of OSX. iOS looks to me to be inhibiting the evolution of iPad; it will be interesting to see if Apple agrees. June at WWDC will provide some answers.

[DCG]

Good post Johnny, although I'm not sure I agree that iOS is holding back the iPad.

 

 

The iPad is great for specific apps that are not great on a smaller screen. I play guitar, and there are incredible Digital Audio Workstation apps and music creation/production apps available on the iPad. I'm talking apps more useful and powerful than the software most high end music studios had used for decades. Some of the same developers tried building scaled down versions of those apps for the iPhone, but it's not the same. I also use my iPad for things like reading the newspaper, where the experience is simply better on a larger device.

 

 

When you talk about having a different operating system, isn't that what something like the Macbook Air is for? I don't think their needs to be something in between the iPad and the Macbook Air (I don't really understand the need for the iPad pro).

 

 

Regarding iPad growth, I think it's largely a combination of larger iPhones (many people who get an iPhone 6+ don't really need an iPad), and a manner of most people who want an iPad already having one. I upgraded my iPad 3 to an iPad Air 2 last year. I probably won't need to upgrade to a new one for a long time.

[rkbabang]

I've changed my mind about the iPad recently.  For 2 years I used my iPad daily and thought of it as indispensable.  Of course I didn't have a smartphone, but I though that I would find the smaller screen of a smartphone as too limiting and would only use it when away from home.  Well, I bought a used iPhone 5S in September and haven't picked up my iPad a single time since.  I love the iPhone always being in my pocket and available, I don't find the small screen very limiting at all.  And in the cases that I do need a larger screen I just turn on my iMac rather than go get my iPad out.  I'm actually thinking of selling it on ebay, because I don't find I have a use for it.  I'm sure I can't be the only person that feels this way.  If I had a larger screen phone like the 6<s/+> that would make it even more useless.  I think for someone without a laptop or desktop computer maybe an iPad would be useful to have a larger screen around, especially the iPad Pro.  Or someone who has a specific use for a tablet (restaurants,medical, other businesses, musicians, etc), but for most people having an iPhone and a desktop/laptop computer makes the iPad unnecessary.  Yes this is anecdotal evidence, but I think this is an explanation for the sales trends.  When the iPhone was 3.5" and underpowered, having an iPad made sense, but with a 4+ inch iPhone and a computer in the house it just doesn't.

[Guest roark33]

Apple shareholders are just unreasonable.  I saw someone on Seeking Alpha (oh god why did I have to read some of those comments *face palm*) saying that Apple "only" needs $471 billion of after-tax cash to repurchase all their stock over the next ten years.  Are you freaking kidding me?  Do you know how hard it is to earn that much cash after taxes?  There is so much of this with the shareholder base, a classic "this time is different."

 

This stock reminds me of DE or NOV.  A PE10 gave you some crazy 40x multiple even though it traded for 10x ttm.  DE even put out a repurchase program for 30% of all their shares outstanding.  A lot of good that has done....

 

And I hate all this ex-currency BS.  No one was ex'ing out the currency impact when it was working in Apple's favor.  These currency impacts also tell you what is going on with the rest of the world; half the world is in recession so taking out currency impact makes things look better than they are. 

 

History says that buying Apple here is buying at the wrong part of their cycle.  That said, haircut profits by 30% and add in repurchases and you're probably looking at 14-15x EPS in a worst case scenario over the next few years.  Hardly the end of the world but I don't see anyone approaching it that way.  Just a lot of investors upset this doesn't trade for market multiples.

 

I am still not sure what you mean by this part about "buying here is buying at the wrong part of their cycle."  2013 comes to mind when Samsung had destroyed apple with the big screen, sales in Q2 13 yoy barely grew, the iPad sucks, etc, etc.  Buying after they introduced the iPhone can't be what you mean? 

 

The lumpiness of sales is a given in a saturated market where the marginal switcher has already come to the dark side. 

 

The dead money, no upside, march Q, what's next,  drumbeat that drools out of the mouth of the financial press make it all the more interesting. 

 

I think the shareholder base issue may create a great buying opportunity.  I am not sure if we are there, but we could get there this year.  It's not high growth, and value hates tech, so who owns this besides the index funds and a few retail people. 

[Palantir]

Johnny-good point. The iPad is great for waching Netflix, but woefully inadequate for doing even light work. The only really good thing about it is the retina display. I would probably never upgrade my iPad Air.

[giofranchi]

You keep saying this and I couldn't disagree more. There are competitive advantages so much stronger than earnings dominance in an industry. Local monopoly (or some other strong scale advantage), IP monopoly, or a strong network effect are all much better forms of competitive advantage. Hell, just within smartphones alone BBRY probably owned 80%+ of the industry's earnings just 10 years ago. Amazon didn't have too much of a huge problem destroying retailer after retailer who controlled the earnings of their retail niche.

 

Well, when you control the great majority of the earnings of an industry, all else being equal, you also should have the means to improve the value proposition of your products and/or services much faster than the competition, putting between you and the competition ever increasing distance.

 

The examples you brought up are both examples in which something was very different instead: management. Steve Jobs stole all Blackberry’s earnings and Jeff Bezos is stealing the majority of other retailers’ earnings.

 

I guess no moats can protect you, if you try competing with guys like Jobs and Bezos! Because they’ll find a way to render your products and/or services obsolete no matter the advantage you enjoy at the beginning.

 

This being said, I don’t see the risk of anything that might render the iPhone obsolete on the horizon yet. Therefore, all the smartphone industry earnings in the hands of a good enough management (though most probably no visionaries nor geniuses) are good enough for me.

 

We will see!

 

Cheers,

 

Gio

 

[Picasso]

Apple shareholders are just unreasonable.  I saw someone on Seeking Alpha (oh god why did I have to read some of those comments *face palm*) saying that Apple "only" needs $471 billion of after-tax cash to repurchase all their stock over the next ten years.  Are you freaking kidding me?  Do you know how hard it is to earn that much cash after taxes?  There is so much of this with the shareholder base, a classic "this time is different."

 

This stock reminds me of DE or NOV.  A PE10 gave you some crazy 40x multiple even though it traded for 10x ttm.  DE even put out a repurchase program for 30% of all their shares outstanding.  A lot of good that has done....

 

And I hate all this ex-currency BS.  No one was ex'ing out the currency impact when it was working in Apple's favor.  These currency impacts also tell you what is going on with the rest of the world; half the world is in recession so taking out currency impact makes things look better than they are. 

 

History says that buying Apple here is buying at the wrong part of their cycle.  That said, haircut profits by 30% and add in repurchases and you're probably looking at 14-15x EPS in a worst case scenario over the next few years.  Hardly the end of the world but I don't see anyone approaching it that way.  Just a lot of investors upset this doesn't trade for market multiples.

 

I am still not sure what you mean by this part about "buying here is buying at the wrong part of their cycle."  2013 comes to mind when Samsung had destroyed apple with the big screen, sales in Q2 13 yoy barely grew, the iPad sucks, etc, etc.  Buying after they introduced the iPhone can't be what you mean? 

 

The lumpiness of sales is a given in a saturated market where the marginal switcher has already come to the dark side. 

 

The dead money, no upside, march Q, what's next,  drumbeat that drools out of the mouth of the financial press make it all the more interesting. 

 

I think the shareholder base issue may create a great buying opportunity.  I am not sure if we are there, but we could get there this year.  It's not high growth, and value hates tech, so who owns this besides the index funds and a few retail people.

 

My phrasing is wrong in that I implied this was Apple cycle specific.  9 times out of 10 if you buy a cyclical product stock as profits roll over you are going to lose money on the stock, even at low teens multiples with a good balance sheet.  But Apple is the "this time is different" stock and I understand the points Liberty and others have made about the moat.  We knew what levers Apple could drive in 2013 (buybacks, bigger screen, China, watch, TV) but what drives the returns now?  For that reason I think the burden of proof is on the bulls even though the bulls want the bears to prove out the downside.  You never knew what would kill off these other profit streams at cyclical company XYZ, you only saw the metrics roll over as something else was happening that investors didn't quite figure out.

 

As far as sentiment goes.... Only 1 sell rating by the sell-side, average price target over $130, 1% short interest, and it's hard to find an Apple bear.  Not that the stock can't go up in face of that but I'm not seeing the major negative sentiment. 

[TheAiGuy]

We knew what levers Apple could drive in 2013 (buybacks, bigger screen, China, watch, TV) but what drives the returns now?  For that reason I think the burden of proof is on the bulls even though the bulls want the bears to prove out the downside.  You never knew what would kill off these other profit streams at cyclical company XYZ, you only saw the metrics roll over as something else was happening that investors didn't quite figure out.

 

As far as sentiment goes.... Only 1 sell rating by the sell-side, average price target over $130, 1% short interest, and it's hard to find an Apple bear.  Not that the stock can't go up in face of that but I'm not seeing the major negative sentiment.

 

These are all reasonable points, but at this price point (and even 15-20% higher) any modest profit growth over 3, 5 or 10 years will drive good returns on the stock. So, form the point of view of a bull, I don't need massive growth, I only 1) existing patterns of sales to not decline 2) modest growth in existing lines of business or in new ones.

 

as for 1): I look at Microsoft and see that they still make a lot of money selling Windows 20 years after Windows 95. IBM's system 360 lasted, what, 20-30 years? If the iPhone's comparable is "computing platforms" then I see no reason why 5 years from now, the iPhone won't be king. There is talk about this cycle speeding up, but the trend has been to smaller computers and computers can already be smaller than we need to interact with them. I presume something else is on the horizon (VR? AI?) but that will take time to crush the iPhone.

 

2) Services, continued growth in china, india, apple watch?

[PatientCheetah]

I think two things do not get enough attention.

1. Like Amazon like to say, your margin is my opportunity. Apple's insistence on selling 16GB products is shortsighted attempt to increase its already skyhigh ASP. After OS upgrades, 16GB version products barely have enough space to install 1 or 2 games, very dilutive to the Apple experience.

2. There has been an increasing popularity in prepaid plans in the US or Apple's biggest market. All the sudden, customers are exposed to the true sticker price of iPhones, instead of $200 every two years, it's $650, $750, $850.

[Palantir]

 

 

These are all reasonable points, but at this price point (and even 15-20% higher) any modest profit growth over 3, 5 or 10 years will drive good returns on the stock. So, form the point of view of a bull, I don't need massive growth, I only 1) existing patterns of sales to not decline 2) modest growth in existing lines of business or in new ones.

 

 

Why will only modest growth suffice? Dividends and buybacks are severely limited by offshore cash and rising debt levels. So what would the catalyst be?

 

In other words, good company, but why is it a good stock, especially in the face of stagnating iPhone sales growth? Growth in China and India (especially the latter, much weaker market) is not going to be enough to offset a slowing US market.

[TheAiGuy]

 

 

These are all reasonable points, but at this price point (and even 15-20% higher) any modest profit growth over 3, 5 or 10 years will drive good returns on the stock. So, form the point of view of a bull, I don't need massive growth, I only 1) existing patterns of sales to not decline 2) modest growth in existing lines of business or in new ones.

 

 

Why will only modest growth suffice? Dividends and buybacks are severely limited by offshore cash and rising debt levels. So what would the catalyst be?

 

My comment was borderline tautological. A 1% perpetuity growth rate is worth ~11x earnings with a 10% discount rate. Apple trades at 10.8x earnings, hence a "modest growth rate" would provide "good returns", depending, of course, on what "modest growth rate" and "good returns" mean -- but lets say I meant 2% growth and north of 10% return.

 

That isn't dependent on any catalyst -- again, borderline tautology -- but you're right, I don't see any catalyst forthcoming.

 

Apple has several years before debt load becomes a problem, assuming earnings do not shrink significantly. There is a massive repatriable 'cash' balance to offset the debt.

 

In other words, good company, but why is it a good stock, especially in the face of stagnating iPhone sales growth? Growth in China and India (especially the latter, much weaker market) is not going to be enough to offset a slowing US market.

 

This seems more skeptical of the business than specifically addressed at my comments, but to retort, China and India are both big countries. The addressable market in China has grown a lot in the last several years and it is conceivable that it will continue to grow, with Apple taking a portion of the market share. India is much poorer, but so was China 10 years ago. It is possible, though by no means guaranteed, that the total addressable market will grow in India as well. With such large populations, the growth in wealth in percentage terms doesn't need to be huge to be material to Apple.

 

"Stagnating growth" is conjecture -- as is my confidence in the health of the business going forward. Growth in China this quarter was substantially less than I'd hoped -- was this a result of a weakening of the product line and or competitive position, or is it the economy? Hard to say. My understanding of the product line leads me to believe the iPhone is more like IBM's System 360 than the Blackberry, which leads me to the conclusion that the business is probably fine and not likely to shrink. Mostly, I don't see another competing platform, so what I see is a slowdown in growth, possibly related to the economy.

[giofranchi]

For that reason I think the burden of proof is on the bulls even though the bulls want the bears to prove out the downside. 

 

I don’t want to prove anything. I am here to talk and share ideas. My idea is the smartphone industry will do fine in the next 5 years. In 2015 there were 2.6 billion smartphone users worldwide, and by 2020 they are expected to grow to 6.1 billion, more than doubling in 5 years. (http://techcrunch.com/2015/06/02/6-1b-smartphone-users-globally-by-2020-overtaking-basic-fixed-phone-subscriptions/#.mgfdu8:RPIH)

 

Therefore, the question is: will AAPL continue to grow alongside the smartphone industry? Or will its business be disrupted somehow?

 

I can think of two ways AAPL’s business could hit a wall:

1) A low cost producer emerges and steals AAPL’s business,

2) A “new Steve Jobs” emerges somewhere else and steals AAPL’s business the same way AAPL stole BBRY’s business.

I do not think 1) is very likely because if you consider the overall quality of the iPhone (hardware, software, and design together) I think its price already offers great value, and imo it is quite difficult to find a better balance between quality and price. 2) is more difficult to evaluate, but that’s where leaving the crumbs in terms of earnings to all other competitors should provide shareholders with at least some safety: with the exception of a new genius who introduces a paradigm shift in the way we think about and use smartphones, not to say a completely new technology, we will continue to use constantly improved versions of basically the same product. And who is better positioned to keep improving than the company which is gathering all the earnings of its industry?

 

This is what I see. Now I would like to hear why the bears think 1) and 2) could easily happen instead. And if they see other ways AAPL’s business could hit a wall besides 1) and 2).

 

Cheers,

 

Gio

 

[Palantir]

^One does not need to steal AAPL's business for it to be a bad investment. AAPL can continue being a highly profitable company and still be a bad investment. See IBM and 2000s MSFT.

[TheAiGuy]

^One does not need to steal AAPL's business for it to be a bad investment. AAPL can continue being a highly profitable company and still be a bad investment. See IBM and 2000s MSFT.

 

Well, IBM *has* lost business to competitors. 2000s Microsoft was fine as a company but  had a large amount of multiple compression (and some bad acquisitions, but that was really 2010s MSFT).

 

 

[giofranchi]

^One does not need to steal AAPL's business for it to be a bad investment. AAPL can continue being a highly profitable company and still be a bad investment. See IBM and 2000s MSFT.

 

Both of them were in industries with very little growth. Not so for AAPL. If you are leader in an industry that continues growing, either someone knocks you out from the leadership position, or you will probably go on growing along with the whole industry. Am I wrong?

 

Cheers,

 

Gio

 

[wachtwoord]

^One does not need to steal AAPL's business for it to be a bad investment. AAPL can continue being a highly profitable company and still be a bad investment. See IBM and 2000s MSFT.

 

Both of them were in industries with very little growth.

 

 

Excuse me? You might want to go look at MSFT's cash flows since 2000.

[giofranchi]

Excuse me? You might want to go look at MSFT's cash flows since 2000.

 

Of course I know! But that's what Palantir was saying: you could be very profitable and still end up being a poor investment... The multiple compression that causes this poor investment performance imo could depend on the lack of growth. I might be wrong...

 

Cheers,

 

Gio

[wachtwoord]

Excuse me? You might want to go look at MSFT's cash flows since 2000.

 

Of course I know! But that's what Palantir was saying: you could be very profitable and still end up being a poor investment... The multiple compression that causes this poor investment performance imo could depend on the lack of growth. I might be wrong...

 

Cheers,

 

Gio

 

Weren't you saying that MSFT and IBM were in an industry with little growth in 2000. I was countering that. (if I misunderstand what you said then my mistake).

[rmitz]

Well, when you control the great majority of the earnings of an industry, all else being equal, you also should have the means to improve the value proposition of your products and/or services much faster than the competition, putting between you and the competition ever increasing distance.

 

The examples you brought up are both examples in which something was very different instead: management. Steve Jobs stole all Blackberry’s earnings and Jeff Bezos is stealing the majority of other retailers’ earnings.

 

I guess no moats can protect you, if you try competing with guys like Jobs and Bezos! Because they’ll find a way to render your products and/or services obsolete no matter the advantage you enjoy at the beginning.

 

This being said, I don’t see the risk of anything that might render the iPhone obsolete on the horizon yet. Therefore, all the smartphone industry earnings in the hands of a good enough management (though most probably no visionaries nor geniuses) are good enough for me.

 

We will see!

 

Cheers,

 

Gio

 

No one really saw the iPhone coming either. Even when it came out it didn’t seem that great—to this day I can still type better on a physical phone keyboard like blackberry or palm.  Yet it was the essential insight that the bigger screen would make the phones so much more useful to so many more people, that was missed.

 

If I had to guess, I’d say that glasses integrated technology is the next step, but that’s just because I already wear glasses every day.  Right now they’re nerdy, but if they get this to market, they won’t be:

 

http://www.engadget.com/2016/01/09/carl-zeiss-smart-lens-curved-glass/

—

 

I also think that Apple has begun to lose sight of fundamental usability in favor of additional functionality/complexity and eye candy design.  It doesn’t seem like Jony Ive knows anything about making products actually usable in a human-computer interaction kind of way, or more likely, he believes that is of lesser importance.

[giofranchi]

Weren't you saying that MSFT and IBM were in an industry with little growth in 2000. I was countering that. (if I misunderstand what you said then my mistake).

 

This is what I meant: growth expectations probably were too high if compared to the growth that actually happened.

 

With AAPL today, instead, growth expectations are almost non-existent... Therefore, I don't get the comparison with MSFT in 2000.

 

Cheers,

 

Gio

[DCG]

I also think that Apple has begun to lose sight of fundamental usability in favor of additional functionality/complexity and eye candy design.

 

 

This.

 

 

There is no single filter before all products are released, which is what Steve Jobs was. They're now releasing things that would not have made it past Jobs' standards.

[valueyoda]

The comparison with Microsoft is not really applicable, but one with Research in Motion is more apt. The fear among investors is that Iphone sales will be cannibalized at a certain point and that operating margins will come down, making the actual p/e ratio substantially higher than expected. However, I do think it is way too early for that.

[TheAiGuy]

The comparison with Microsoft is not really applicable, but one with Research in Motion is more apt.

 

The bull case is exactly the opposite of this

[dabuff]

Exactly. This is not quite RIMM, nor is it MSFT. The stock appears priced for no growth, but there are several competitive advantages that are working in the company's favor. AAPL has customer captivity (it is unusual among tech companies in that a way it is also a fashion/luxury brand).

 

And we have the potential white swans such as an Apple car down the road.

 

[Liberty]

Nice compilation of numbers from the last Q by Horace Dediu: