Stockwatch: Good reasons to remain bullish on Apple shares

by Edmond Jackson from interactive investor |

Timing entry remains tricky, but our companies analyst comes up with plenty of reasons to buy Apple.

With Nasdaq-listed shares in Apple (NASDAQ:AAPL) resurgent, is this hardware producer undertaking a similarly successful transformation towards services, quite like Microsoft (NASDAQ:MSFT) embraced "cloud" to refresh growth and re-invigorate software sales?

Last year, Apple fell 35% from its August all-time high of $228 to $148 at year-end, though has soared 43% in 2019 to $212.

The uplift comes despite iPhone sales slowing to represent 53.52% of group sales, down 17.3% like-for-like in Apple's Q2 (January to March), although the smartphone replacement cycle is slowing generally from three to four years and US carriers such as Verizon (NYSE:VZ) and AT&T (NYSE:T) are citing record lows for smartphone upgrades.

While this stock can move significantly on market sentiment shifts, it looks as if it may be starting to shrug off perception for reliance on the iPhone.

Wednesday's trading saw a 5.5% rise in reaction to the Q2 results which modestly beat consensus (though Apple has appeared to guide cautiously). Earnings per share (EPS) of $2.46 was ahead of the $2.37 expected, and revenue was $58 billion versus $57.5 billion expected.

iPhone revenues were $31.05 billion versus $30.5 billion expected, and various new products/services are growing well such that Q3 sales are guided higher, potentially up to $54.5 billion versus $52.2 billion consensus.

Buying back 7.5% of the issued equity

More is needed to trigger this extent of rise however: I suspect it's conservative investors warming to the share buyback programme, increased to $75 billion in context of a circa $975 billion market cap, despite others wondering if Apple is losing its radical disruptive edge from the Steve Jobs years.

By comparison annual capital expenditure is just $5.7 billion.  Yet, technically, buybacks may help support the stock which also offers a not immaterial yield of 3% as the dividend rises by 5%.

In terms of risk/reward profile, the historic price/earnings (PE) multiple of 17 times is nowhere near the nosebleed levels of enough other US tech-stocks.

Source: TradingView   Past performance is not a guide to future performance

So, Apple is starting to look useful to hold now that its service offerings are growing fast - thus potential for recurring revenues from subscriptions and the like, possibly redefining Apple quite like a tech-based utility company.  This could, if successful, reduce the stock's perceived risk, hence volatility too.

Product portfolio substitutes new drivers for growth

Within products, iPhone and Mac sales continue to fall but iPad and Apple Watch are growing.  Remember how the Watch initially met with scepticism at launch four years ago but in time has become a best-seller.

Recently, Apple has released a string of new laptops and desktops, a dip in Mac sales blamed on processor constraints than anything design-related.  Discounting the iPad Pro has helped boost iPad sales to the strongest in six years; similarly, price-cutting of iPhones in China towards the end of Q2.

China has become a bit of an issue in the hardware story, where the arrest of Huawei's CFO in Canada led Chinese businesses to call for a boycott of Apple, telling employees they would receive subsidies to buy Huawei phones.

A social campaign against Apple also included trade war issues versus the US hence Apple management says a late Q2 surge in China was helped by improving consumer confidence linked to the tone of US/China trade negotiations.

I incline also to see the dilemma about how iPhones face tough competition from Chinese local brands Huawei/Honor - high-spec smartphones that are the keenest-priced globally.  Apple is significantly relying on Chinese consumers' believing the iPhone has premium brand appeal, but it really is down to personal preference (also versus Android phones). Huawei also increasingly leads reviews versus Apple.

"AirPods" – wireless earbuds first introduced in 2016 and which Apple reckons could become a cultural phenomenon - have had supply issues, and management remains stretched to keep up with demand.  A sense of exclusivity could however continue to tease long-term demand.

March has seen the launch of an Apple credit card, partnering with Goldman Sachs, where a sense of superiority from owning a laser-etched titanium card versus regular plastic, may catch on.  And September is rumoured to herald a strong series of upgrades in Apple's hardware suite. 

Thus, product positioning looks encouraging overall, also as a means to selling a whole variety of lifestyle services Apple is morphing towards.  The 'buy' rationale I originally laid out at $71 (adjusted for stock split) in August 2013, when the stock traded on a modest 12.5 times earnings, was based on a major refreshment of products underway.  It has taken some years to bear fruit, again quite like Microsoft's diversification.

Developing countries – especially India – are an area to watch for Apple's manufacturing and potentially retail.  It presently has a sub-2% market share in India and no stores operated itself, but once manufacturing gets underway then Apple is likely to start opening stores later this year, or in 2020.  

Given the size of the Indian consumer market, it offers leverage, though would seem to need lower pricing which could cause controversy among developed country buyers.

Apple Inc - fiscal year 2019 Q2              
Net sales by category     Three months ended     Six months ended  
$million     30-Mar-19 31-Mar-18   30-Mar-19 31-Mar-18
iPhone     31,051 37,559   83,033 98,663
Mac     5,513 5,776   12,929 12,600
iPad     4,872 4,008   11,601 9,763
Wearables, home & accessories     5,129 3,944   12,437 9,425
Services     11,450 9,850   22,325 18,979
Total net sales     58,015 61,137   142,325 149,430
By geographic area:              
Americas     25,596 24,841   62,536 60,034
Europe     13,054 13,846   33,417 34,900
China     10,218 13,024   23,387 30,980
Japan     5,532 5,468   12,442 12,705
Rest of Asia Pacific     3,615 3,958   10,543 10,811
Total net sales     58,015 61,137   142,325 149,430

Investor attention slowly shifts to services

A key reason I remain fundamentally bullish on Apple is its innovation in services which enjoy gross margins in a 60% range versus hardware in a 30% range.  Thus, along with profits growth in years ahead (with EPS boosted by fewer shares in issue), it is possible that as we've seen Microsoft's PE multiple re-rate, then Apple's could too.  Presently it's estimated to be trading at a 10-20% discount to the wider US market multiple.

In Q2, services revenues grew 16% like-for-like to represent near 20% of group total, but in earnings terms that's 35% and Apple's strategy is increasingly to sell hardware as a service.

Admittedly, prospects are speculative as to how successful the various service strands can prove, which is why Wall Street consensus opinion continues to see a hardware company and apply 'Hold/Take Profits' stances.  But I suspect this reflects how industry analysts are prone to get dug into their views - most following Apple will be hardware-oriented - and a generalist perspective may better sense the shift underway.

Last March Apple declared various new software initiatives such as News Plus which bundles popular magazines and newspapers. Apple is also investing substantially to create subscription gaming, offering Apple Arcade and Apple TV Plus with original TV shows and movies. It's due to launch this autumn.

Myriad options are mooted for development such as ride sharing, home security, education, financial funds transfer, healthcare services and personal/business data.

Be patient and take a multi-year view

The future crux issue is how well Apple can evolve these services without blowing cash.  There's definitely potential for better quality earnings and their rating, on a two-to-five-year view. 

Timing entry remains tricky: perhaps the interest generated by these results will abate and wider market volatility return, making it better to wait for lower prices.  Who knows?

Fundamentally, I think management has a better chance of repositioning Apple than the sceptics who say Steve Jobs' creativity is missing. This company is very well positioned and resourced to "make its own luck" with services, capitalising on a huge network of devices and brand loyalty.  Consider your risk appetite but I reckon broadly: Long-term buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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