We reviewed our position on Apple and increased our price target from $152.18 to $200.00. The increase in price target was a result of an increase in our forward multiple from 13x to 17x (in line with the market).
We were more conservative than the market post Q119 results. We had commented that on a forward P/E of 13x, the shares appeared cheap. However, Tim Cook having lowered guidance due to the trade war affecting the Group negatively, we felt the defensive stance was warranted. Also, PMI data coming out of China and the inverted yield curve in the US were indicating further risks ahead.
However, the PMI data issued in March was positive for China and could be a turning point for global economic growth. HSBC’s comments that they expected growth in China of 6.6% for 2019 compared to consensus of 6.2%, could mean further upgrades to growth will come due to expansionary measures in place.
Our major concern with Apple is that gross profit margins have peaked and in order to see any improvement, we need to see the launch of new products.
However, it is also true that the Company is also doing well from its services segment, which is a high margin business. We believe the better than expected Services margin is likely to drive upside to investor expectations for intrinsic value of Apple shares by becoming a higher portion of the company's profits and increasing investor confidence in assigning a premium valuation to the Services opportunity relative to hardware businesses.
At least for the time being, we believe Apple’s historic robust double-digit growth is behind the company and at least in the short-term, it doesn’t appear that there’s any catalyst to turn them around in order for us to have a Buy rating on the stock.
Recent Launch
Apple's Spring Event took place on 25 March, following a week of hardware launches that saw a new iPad mini, the re-launch of the iPad Air, new iMacs and new AirPods. The Spring Event was all to do with its new subscription services TV+, News+ and Apple Arcade, plus the announcement of its Apple Card credit offering.
Investment Rationale
We maintain our Hold recommendation on the stock with a price target of $200. This reflects a forward multiple of 17x given reduced macroeconomic risks.
Given its revenue base and size, Apple's recent growth has been impressive. However, with 80% of the company's sales exposed to secularly challenged businesses, we believe the long-term growth outlook remains limited.
As a positive note, we expect services revenues to continue to increase in the years ahead contributing positively towards the top line and margins of the Group.
What should investors do?
The question is whether to buy/sell or hold given the weakness in the shares. 2019 started off on a bad footing given the negative data continuing to come out of China. Being at the last stage of the economic cycle, this obviously creates alarm in the markets and the increased tensions between the US and China are not helping the cause.
A trade agreement between the US and China would be positive whereas further trade tensions will weight on the stock.
Given the fact that the Group kept on increasing the price of their iPhones in the late stage of the cycle can be dangerous if there are signs of economic weakness.
We are of the view that the current price of Apple shares reflects its fair value. If economic data continues to come out positive and consumer confidence starts to improve, we could see further upside on the shares. The next set of results (scheduled for 30th April) will be crucial to see margins reported.
Valuation
Our $200 12-month price target factors in a discount rate of 10% and a forward Price-to-earnings multiple of 17x.
We are forecasting gross margins of 38% and 38.3% in 2019 and 2020 respectively. Our model also reflects an income tax rate of 17% going forward.
Concerns
Maturity carries its costs. Up to now the Apple brand has consistently represented the cutting edge of innovation. However, outside the core customer base, there is increasing recognition that competition is fierce and probably ahead on many fronts.
In its latest iteration of the iPhone, Apple has included fast charging and improved its screens. However, both have been available to competition for years. Apple makes up for this by designing its own chips and software, which are incredibly fast, and having a vast eco-system that incentivises loyalty.
The ability to maintain high margins also helps the bottom line. However, for the longer-term Apple is still expected to produce its magic and come up with another lifestyle changing product. Apple has set the bar very high, and probably Apple’s most glaring weakness is the height of that bar.
Conclusion
While Apple is showing signs of maturity, Apple’s loyal customer base provides revenue stability. Additionally, we believe that investors will still be rewarded due to lower taxation, dividends and share buybacks.
This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri at Calamatta Cuschieri. For more information visit, https://www.cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.