Thursday, September 17, 2015

Apple Still a Firehose Stock. Trades Like a Garden Hose. Has to be Owned at Current Prices.

With its innovative combination of technology and design, Apple Inc. continues to  create entirely new categories of consumer demand where none existed before.  Along with Netflix, Apple is transforming wired and wireless communication into a consumer necessity, which will become ever more central to daily life. 

Apple is a cash machine and a bank which produces high end consumer products in a highly developed eco system, that can absorb additional offerings on a regular basis.  The iPhone, though 60% of Apple’s sales, is in control of its own strategic destiny as the tech brand which marries innovation in design and engineering. iTunes is a next-generation media distribution entity with good growth and high margins.  As market leader, Apple generates huge cash flow, which it has begun to return to shareholders through dividends and a large share repurchase program. 

For its size Apple’s sales and earnings and cash flow are growing at extraordinary rates. “In the third quarter our year-over-year growth rate accelerated from the first half of fiscal 2015, with revenue up 33 percent and earnings per share up 45 percent,” said Luca Maestri, Apple’s CFO. “We generated very strong operating cash flow of $15 billion, and we returned over $13 billion to shareholders through our capital return program” 

Yet last month, Apple shocked investors with a “miss” on iPhone unit sales and revenues. iPhone unit revenues were up 59%, 49 million units but somewhat less than the 51 million units that the street was expecting. Make no mistake, however, these numbers are still unbelievable. Repeat unbelievable. 

At the same time, Apple’s balance sheet has over $37 per share in cash despite returning billions in a share repurchase program and in dividends. 

Still, the question for investors (who marked the shares down almost 10% to $122 per share after the release) is a simple one. Is Apple still the same Firehose company they thought it was?  Answer: yes! three reasons:
  1. The company’s products command increasing consumer attention.  
    • iPhone Unit average prices have surged to record levels,  
    • Mac’s sales are expanding in a shrinking pc market, increasing numbers of Android based phone users are switching to iPhone (iOS), 
    • bringing even more users to the iOS ecosystem. 
  2. The company continues to innovative.
    • Apple Pay has found increasing acceptance among large retailers and banks, while an alternative offered by a consortium of retailers has no bank partners and has yet to exit trial stage.
    • while many techies and investors have yet to find a killer use for the Watch, Wristly reports that non techies users have embraced the watch. At the same time, the company has released beta versions of the WatchOS2 which supports third party developed apps—and could generate the killer app the techies and gurus are demanding. 
  3. Despite supra-normal growth in sales and earnings, the company continues to return cash through its share repurchase program and higher dividend program and to add to its cash and securities pile of over $212 billion. 

This is really unbelievable. But are the shares cheap. Even discounting the off-shore cash (around $190 billion) by 25% to reflect some kind of repatriation deal—twice Apple’s current tax rate—cash amounts to $28 per share. Dividing the remaining non cash portion-$96 per share—on  Fiscal Year 2016 estimated eps of $9.75 yields a pe of 9.85 times. If the non cash portion of the share were to trade at 14 times (a 10% discount to the market) the share price could rise to ($28 cash portion plus $136 operating portion)  $164 per share, a 32% increase. In other words a trillion dollar market cap is both feasible and likely. 

This estimate does not reflect potential growth in earnings or cash or increases in the dividend. Yeah, truly a virtuous circle in biz school language. 


Could the stock get cheaper? Sure. First, there is no suggestion that cash in the company’s off-shore accounts will be repatriated any time soon—arguing for a deeper discount on the cash portion. Second, maybe the miss in third quarter earnings will recur in the fourth quarter, ending September 30; though by then, the company will have five days worth of sales from the 6s series of iPhones and its other innovative products will have begun to gain traction in the marketplace. Lowest I see the shares is somewhere close to $115. But, I am a buyer at current prices. 

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