Warren Buffett's largest holding!
SHARE PRICE: $154,78
MARKET CAP: $731B
1. INTRODUCTION
Since we’re right in the middle of earnings season, and given the fact that I’m trying to grow my audience, I’m going to take a look at Apple.
2. BUSINESS OVERVIEW
2.1. BUSINESS DESCRIPTION
As we all know Apple’s core business is designing, manufacturing and selling tech products. Apple started out at Steve Jobs garage in Cupertino back in 1976, and it was the first company ever to reach 1 Trillion dollars in Market Cap.
I’ve said that it sells tech products but that doesn’t tell the whole story. Let’s check out everything the company does in a minute. Although I am quite familiar with the company I will take a look at its website.
2.2. LARGEST SHAREHOLDERS
The main shareholders are the usual suspects, the big funds. One not so usual suspect in the tech world is Warren Buffett with his Berkshire Hathaway coming up in 2nd place. Buffett has been buying recently and he says he loves the company so much that he would like to own 100% of it. Will he do it? Well, that would be the biggest deal ever to be made and we’re not here to talk about it, at least this time.
2.3. MANAGEMENT TEAM
We all know Tim Cook and I think it’s more than fair to say that he has shattered all doubts about whether he was going to be a good leader or not. He didn’t lose focus of Apple’s core products, he didn’t lose it with the M&A strategy, and he has led the company to become a spectacular cash machine, with the biggest balance sheet ever while becoming one of the the most valuable companies in the world. So it’s pretty fair to say that he has been the CEO Apple needed.
3. HISTORICAL CONTEXT
3.1. LONG TERM CHART
Apple’s stock price is $154,78 right now.
What an amazing chart, specially after the launch of the first iPhone in 2007. The people that held it for all these years have a great reason to be happy right now (yeah, even with the recent correction).
3.2. MARKET CAP AND SHARES OUTSTANDING
Notice the Market Cap rising even when the company is buying back shares from 2012 onward. The recent 1 Trillion dollars valuation is not shown here as the chart only takes into account year end results. The Market Cap is now $731B.
Just recently Apple has completed a massive “Share Repurchase Program” and it has put in place another huge one for $100 Billion.
3.3. SALES - OPERATING INCOME - OPERATING MARGIN
Sales for 2018 were $266B and the analysts consensus is for it to go down this year, and then back again.
Sales have been rising at a compound annual rate of return of 16% for the last 30 years, 22% for the last 10 years and 9% for the last 5 so we’re looking at a company well past its high growth stage. Apple is a mature company now.
Note: Apple’s fiscal year ends in September.
3.4. SALES BY GEOGRAPHY
The Americas represent 42% of sales and Europe 24%. In recent years China has been lagging behind coming down from a 2015 share of 25%, 2016 share of 22%, 2017 share of 20% to 19,5% in 2018.
3.5. SALES BY SEGMENT
Obviously, the iPhone is the largest contributor to Apple’s revenue and the reason for much of the media buzz we hear these days. Services comes in a far second place, representing 14% of total revenue.
For the first time in its history, Apple has disclosed a “Services” gross margin of 63% in the 1st quarter of 2018, up from a 58% in 2018.
3.6. SALES EVOLUTION BY SEGMENT
I’ve decided to separate iPhone from all other categories because we wouldn’t be able to see the sales trends in detail otherwise.
“Services” grew 26% in 2018 alone but it has a lot to grow before we can start comparing them to the iPhone sales. The “Other Products” category represents the smallest share of the pie but they are coming up at a good pace as well, having grown 35% in 2018. iPad and Mac sales have been declining for the last 5 years.
And now, for the whole picture, let’s put iPhone in there too:
Still a long way to go before we’ll be able to say “Apple is a well diversified tech company”.
Humm……. Now that I come to think about it, from a purely mathematical point of view, at 23% year on year growth, services could reach the $100B mark in just 5 years!!!
3.7. NET INCOME, NET MARGIN
Clearly Net Income shows a rising trend, although in some of the recent years it has dropped. Apple reports better earnings in the year immediately after a new iPhone is released and, in the following years, earnings drop hard. It’s called the iPhone Super-cycle.
Given the fact that Apple is aggressively buying back its own shares, the EPS (earnings per share) growth is bigger than the Net Income growth. Let’s take a look at an example: Net Income in 2018 was $59,5 Billion growing 23% from $48 Billion in 2017. When we apply the same math to the EPS from 2017 to 2018 the growth rate goes up to 28%. Don’t you just love Buybacks? (yes, I know the arguments against share buybacks. More on that later.)
Apple has been able to raise and maintain net margin at levels above 20% for the last 5 years which is amazing given the fact that competition is increasing and the Smartphone market is leveling off.
The company is aware of that and it has pursued a strategy of selling less iPhones rather than lowering its margins. Yesterday, facing questions about declining sales of the iPhone, specially in China, Tim Cook commented on the possibility of lowering the price of the iPhone.
He also said recently that Apple will stop reporting the number of iPhones, iPads and Imacs sold. As the company tries to shift into a more services focused company, they don’t consider it an important metric anymore. Some said it was a way of hiding future decline in sales, and we can see now that they were right.
3.8. RESEARCH AND DEVELOPMENT
The investment made in R&D is increasing every year on a nominal basis, as well as when we compare it to total sales. In 2018 this expense amounted to 5,3% of total sales while back in 2012 it was just 2,2%.
3.9. SEASONALITY
There is high seasonality to Apple sales, the first quarter being the strongest one due to the holiday season.
Note: Apple’s fiscal year starts in September.
Statista
3.10. DIVIDENDS
With the stock trading at $154.78 right now, the dividend yield is 1,89%.
3.11. PROFITABILITY RATIOS
This is one of the indicators I like best when analyzing a company. Although it’s good for a business to show high margins, I like to take a look at the return on equity too.
Warren Buffett likes to see ROE above 20%. Apple clearly excels at this metric.
3.12. FINANCIAL RATIOS
An optimal current ratio would be above 1.5 and an desirable Debt to Equity ratio would be bellow 0.5. Let’s take a look at Apple’s Financial Ratios.
Current ratio has been diminishing over the years, but it is at a perfectly healthy level.
One thing the Debt-to-Equity ratio doesn’t take into account is that Apple has a $243 Billion pile of cash burning in its pockets, while the debt is “just” $103 Billion. So why does Apple would even want to get into debt with all that money?
Well, because until the Tax Cut and Jobs Act got into place, bringing that cash home would be more expensive (because of the taxes) than the interests on the debt. Now that the TCJA is in place, Apple (and other U.S. companies) can bring home that cash paying just a one off 15,5% tax rate.
3.13. PRICE TO EARNINGS RATIO
For the last 10 years, roughly since Apple launched the iPhone, the PE ratio has been around “normal” levels for such a high quality company and is now at around 13. (Not taking into account its massive pile of money). When we take net cash into account, the adjusted PE ratio is about 11! I can almost bet that old Warren is rubbing his hands with a big smile on his face.
3.14. RISKS AND COMPETITION
From the lastest 10K I chose to isolate 4 main groups of risks in order of importance:
1- Competition and ability to innovate: Apple’s innovations may not be what clients desire.
2- Privacy: A hot topic right now. A privacy scandal would undermine Apple’s solid reputation.
3- Macro Environment: As a consumer business Apple is affected by the ability of its clients to pay for its not so cheap products. We’re witnessing happening this right now.
4- Supply Chain: With increasing worldwide demand for raw materials, and products getting more complex, Apple has to be sure it’s suppliers don’t make a mistake.
3.15. TYPE OF PLAY
I consider Apple a Slow Growth Stock that will in time become a Dividend Play.
5. OVERVIEW AND CONCLUSION
5.1. OVERVIEW
Before wrapping up I would like to make a few notes on Services and the iWatch:
“Services” is the bet most people are making to be the future growth driver for Apple. “Services” revenue has been growing at a rate of 23% per year. It’s already about 14% of total sales and Apple expects it to achieve $50 billion by 2020. Assuming no growth from here on for the other products, that would represent 20% of sales.
Apple is slowly but surely transforming the iWatch into a “health diagnostic device”. HealthCare is a whole different game and a huge one for that matter. The day will come when you can check your insulin levels with a SmartWatch, immediately uploading the results to the cloud and to your doctor’s file. And who would you trust to keep all your medical files and data? One of the most reliable brands in the world, or a company you can’t even pronounce its name?
I’ll leave you with a quote by Tim Cook during an interview with former European Competition Commissioner Neelie Kroes:
“I love the watch. One day, this is my prediction, we will look back and we will wonder: how can I ever have gone without the Watch? Because the holy grail of the watch is being able to monitor more and more of what’s going on in the body (…) It’s not technologically possible to do it today to the extent that we can imagine, but it will be.” – Tim Cook
Unlike other tech companies right now, Apple isn’t valued as a growth company. In fact, as we can see by looking at the PE chart, that has been true for the last 10 years, although Apple sales have grown nine fold in that period. Having said that, Apple is now a mature company and it won’t grow as it grew in prior years.
It will be difficult for Apple to deliver another big disruptor product as was the iPhone back in 2007. We’re talking about a Smartphone company and its success will always be tied to their latest upgrade.
On the other hand, there are iPhones spread across the world and the potential of all this hardware on the hands of billions of customer’s isn’t something we should underestimate. Nor should we underestimate Apple’s ability to come up with new products and features in the coming years.
Let’s be conservative and say that the company doesn’t grow at all from now on. In 10 years time, it will have amassed $660B in net cash. It will be generating somewhere around $65B a year (at a 25% net margin in 2029), which at a PE of 20, leads to a $1,3T valuation. If we add those $660B in net cash, we get $1,95T valuation. Assuming they don’t buy back anymore shares (I’m sure they will), this leads to a $411 share price or a 10% CAGR from the current $154,78.
5.2. CONCLUSION
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