Thesis:
Apple (AAPL) is at a price point, which I believe offers attractive return potential to investors on cost. While Apple has seen iPhone sales decline significantly in 1Q19 from 1Q18, I believe growth in its other segments (Mac, iPad, etc.) as well as the proprietary nature of those products will stabilize the iPhone sales decline and result in FY19 revenue growth. Growth in the smartphone market has also crushed forecasts and is still poised for strong growth moving forward; a macro trend that plays well for Apple, considering it controls approximately 24% of the global smartphone market share. With that being said, I recommend Apple shares at current prices and anticipate them to return approximately 8% with dividends to shareholders by the end of FY19 on cost.
Apple’s Strong Product Segment Growth And What It Can Do For iPhone Sales:
Other than iPhones, Apple grew all of its other segments in 1Q19 from 1Q18. It saw approximately 8.7% growth in Mac sales, 16.9% growth in iPad sales, 33.3% growth in Wearables, Home, and Accessories sales, and 19.1% growth in Services sales. All the while, iPhone sales fell 15%, resulting in a net sales loss of approximately 4.5%. While seeing Apple’s trademark product lose 15% in net sales from the same time a year ago is intimidating, I believe Apple’s proprietary product line will stabilize iPhone sales moving forward. What I mean by stabilize is, I believe iPhone sales will be equal to or greater than (15%) in the remaining three quarters of FY19 in comparison to the respective quarter in FY18. Apple’s products are extraordinarily integrated with one another. As Apple’s other segments grow, I anticipate the proprietary nature of Apple’s products will stimulate iPhone sales, as it’s essentially necessary for compatibility purposes.
(Image and Information Source – Page 1)
Global Smartphone Market Growth Crushes Forecasts And Breeds iPhone Sales Growth Hopes:
Global smartphone market growth crushed Statista forecasts. The most recent data from data pegged 1.86 billion active smartphones at the end of 2015, with forecasts for that number to reach 2.53 billion by the end of 2018. However, a report by Newzoo found that there were roughly 3.3 billion active smartphones globally by June of 2018. With approximately 3.3 billion smartphones by the end of FY18, actual growth outperformed forecasts by 30.43% and grew at a CAGR of 21% from FY15’s figure of 1.86 billion. Newzoo is forecasting 3.8 billion global smartphone users by 2021, which would represent a CAGR of 7.4% from FY19 to FY20.
Apple currently controls 24% of the global smartphone market share with 800.7 million active devices as of June of 2018. Should Apple maintain a market share close to 24%, it should be able to realize approximately 1.78% CAGR growth in iPhone sales over the next couple years from global smartphone growth. I get that figure by taking Apple’s market share portion of the global smartphone user growth rate of 7.4%.
Seeing strong growth in global smartphone users is beneficial for all players in the smartphone industry. The figures above show the amount of growth potential that still exists in the global smartphone market, and I believe Apple will find a way to take its share. In all, based on the data above, we can expect Apple to see iPhone sales naturally grow by approximately 1.78% over the next couple years so long as global smartphone market forecasts are met.
I personally don’t anticipate Apple seeing many more quarters of iPhone sales decline, at least at the level that we saw in 1Q19. Apple is set to release 2Q19 earnings on 05/07/2019, which is going to provide valuable data to interpret. However, in the meantime, I am going to run my quantitative analysis on the contingency that Apple loses 15% of iPhone sales in each of the remaining FY19 quarters in respect to the same quarter a year ago. I would like to note that should Apple produce iPhone sales > (15%), identical sales, or iPhone sales growth in any of the remaining FY19 quarters from the same respective quarter in FY18, the value of the opportunity I’m addressing in this article gains more depth.
Quantitative Analysis:
Apple’s 1Q19 revenue was $84,310 million, with 61.65% of that coming from iPhone sales, and 38.35% of it coming from its other segments. I would like to note that iPhone sales accounted for approximately 69% of Apple’s revenue in 1Q18. While iPhone sales declined 15%, I do anticipate them to grow at a rate of 1.78% derived from global smartphone market growth of 7.4% in relativity to Apple’s global smartphone market share of 24%. I forecasted Apple’s 2Q19-4Q19 iPhone sales figures by cutting the previous years’ quarter by 15% then multiplying the sum by the growth rate of 1.78%. This method of forecasting anticipates and accounts for 15% losses in iPhone sales in 2Q19-4Q19, accompanied by a modest growth rate of 1.78%. Using the data above gives us 2Q19 iPhone sales of $38,362 million, 3Q19 iPhone sales of $35,399 million, and 4Q19 iPhone sales of $41,803 million.
Apple’s other segment revenue (Mac, iPad, Wearables, Home, and Accessories, and Services) accounts for 38.35% of its revenue. Combined, other segment revenue came to $27,189 million in 1Q18. In 1Q19, other segment revenue came to $32,328 million combined, representing YoY growth of 18.9%. I anticipate that Apple will see slightly lower YoY quarterly segment growth of 15% in 2Q19–4Q19. I forecasted other segment revenue using a nearly identical method as I did forecasting iPhone revenue for FY19. I take 38.35% of previous years’ respective quarterly revenue, as that’s the percentage that accounts for Apple’s other segments. I then multiply each quarter’s revenue figure by the growth rate, in this case 15%, to get our forecasted segment revenue for 2Q19–4Q19. This gives us 2Q19 other segment revenue of $26,963 million, 3Q19 other segment revenue of $23,491 million, and 4Q19 other segment revenue of $27,740 million.
NOTE: The graphic above is a visual representation of why I am forecasting Apple’s 2Q19–4Q19 revenues using the same quarter from a year ago versus the most recent quarter. A consistent quarterly sales pattern develops in 1Q12 and carries on to the end of the graph. Apple obviously sees extraordinary first quarter results as a result of the holiday season, thus, we can’t use 1Q data to predict 2Q and vice versa.
Combining our 2Q19–4Q19 iPhone revenue forecasts and other segment revenue forecasts gives us a forecasted FY19 total revenue figure of $278,068 million, representing 4.7% growth from FY18. Apple has a five-year average net margin of 22%, which I believe will be maintained. With a 22% net margin, we get a forecasted FY19 net income figure of $61,175 million, which translates to forecasted FY19 EPS of $12.95. Apple has traded at a five-year average P/E ratio of 15.7, which is a reasonable earnings multiple for Apple. With our forecasted FY19 EPS of $12.95 and an earnings multiple of 15.7, we get a FY19 price target of $203.32, representing upside potential of 7.95% on current cost. Apple also provides a 1.55% dividend yield on cost, which would translate to a return of 9.5% on cost if held for at least a year.
The Opportunity at Hand:
The opportunity at hand is brought to fruition by Apple’s ability to grow its other segments at impressive rates, and its ability to produce earnings growth in the same quarter that iPhone sales – 61.65% of Apple’s revenue stream – dropped 15%. In my quantitative analysis, I outline how Apple can grow FY19 year-end revenue by approximately 4.7% from FY18. With upside potential of as much as 9.5% amidst struggling iPhone sales, a valuable opportunity exists within Apple under the contingency that it can stimulate iPhone sales before the end of FY19. Even with iPhone sales dropping 15% with each preceding quarter of FY19 on a YoY basis, I still forecast solid revenue and earnings growth. With that being said, Apple’s 2Q19 earnings report will provide strong insight into how iPhone sales are currently faring. If Apple can post strong 2Q19 iPhone sales, I strongly believe its stock and shareholders will be duly rewarded.
Associated Risks:
While I feel confident in Apple’s competitive edge and ability to thrive in both the short and long term, there are certainly some risks to keep in mind. In Apple’s case, I currently only find one big concern, and I think it’s obvious – market share loss.
I have worries that Apple may be overly focused on catering to the high-end cell phone market. All of Apple’s devices are top-end. However, its quality comes with a price tag that many can’t afford, especially in developing markets, which is where Apple is losing ground to the likes of Samsung (OTC:SSNLF). In fact, Samsung has passed Apple as the leader in the global smartphone market, controlling 27% compared to Apple’s 24%. It’s also not good seeing Samsung passing Apple due what appears to be market share absorption, as Apple lost users while Samsung gained them.
China also has some other big players in the global smartphone market that are proving to hurt Apple. Oppo, Xiaomi, Huawei, and Vivo are the world’s 3rd, 4th, 5th, and 6th largest global smartphone providers respectively, and control 33% of the global market combined. These companies are making impressive smartphone devices with starting prices of less than half of that of Apple’s cheapest model of the new iPhone. The graphic below shows the margin gap between Apple and Samsung. However, margins can only make up for so much of a lack of sales. Apple saw iPhone sales in the Greater China region drop 27% in 1Q19 from 1Q18. If Apple doesn’t find a way to cater to lower-end markets, I’m concerned its global smartphone market share may be in serious danger.
With iPhones consisting of 61.65% of Apple’s revenue stream, it can take many more sales loss hits without putting Apple’s stock in jeopardy. If iPhone sales plummet, Apple could see quite large market price drops. Due to the weight that Apple investors put on iPhone sales, and considering they’ve been rocky, I believe an investment in Apple could drop as much as 25% in market value should iPhone sales remain turbulent. While Apple is not a volatile company, it has seen price drops of that significance in the past. Most recently, it dropped from roughly $225 per share in October of 2018 to around $148 per share by January of 2019, roughly a 35% drop in market price in under a quarter.
With that being said, I believe in Apple’s ability to recapture global smartphone market share and compete at a superior level to its peers. However, market share is something worth monitoring without bias, as even Apple could face serious trouble should it start losing too much market share.
Conclusion:
In conclusion, I believe Apple’s other segment growth will help stabilize and potentially stimulate iPhone sales. I believe this has a likely chance of occurring due to the proprietary nature of Apple’s product line. In turn, global smartphone users are still exhibiting strong growth, providing an opportunity for Apple to regain and continue to grow its market share. Apple has fared well recently with all things considered. Even with slumping iPhone sales, my analysis still paints Apple as undervalued. If Apple produces strong iPhone sales moving forward in FY19, they will reap the benefits. In fact, if Apple posts identical iPhone sales in 2Q19, I could see its stock arriving at a $225 price target before the end of FY19, representing upside of nearly 20%. If Apple posts results similar to what they produced in 1Q19, I forecast they will reach my other price target of $203.32, representing 7.95% upside before dividends, and a 9.5% upside after dividends on current cost. With that being said, I recommend shares of Apple at current prices with an expected return of at least 8% by the end of FY19.
Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
