LARRY SMITH Seeking Alpha
Let me start with a confession, I do not own any Apple (AAPL) products, not even an iPod. I have family members who have iPods and iPhones, but I do not, so I think it is fair to say I am not a fan boy. I am a stock investor and I would like to think I look at stocks as investment instruments and no more. In the past, I had no interest in AAPL, it was a high-flying growth stock and it did not pay a dividend, which is not my cup of tea. I am a dividend growth investor looking for reasonably priced stocks that pay a nice growing dividend. Until recently, AAPL did not pay a dividend so I had no interest, although I did realize some investors were making a great deal of money on their AAPL investment.
Only recently did I become interested in AAPL, first catching my interest when it started paying a dividend and second, when the stock price plummeted from a high around $700.00 down to under $450.00. A dividend that is likely to keep growing and a stock price that has fallen is my kind of stock. So I recently began researching AAPL; I read annual reports, listened to conference calls and read research reports. All of my research has lead me to a simple conclusion; AAPL is dirt cheap and should be bought.
The Business – Apple’s most recent quarter showed record sales for iPhones and iPads and declining sales of Mac computers. Revenue for the quarter grew to $54 billion up from $46.5 billion in the year-ago quarter. What makes the gain even more impressive was that this quarter was one week shorter than last year. Average revenue per week this quarter was $4.2 billion up from last year’s $3.3 billion, a gain of 27%. Below are some other highlights from the recent quarter.
- Sold 47.8 million iPhones compared to 37 million a year. On a weekly basis, AAPL sold 3.7 million iPhones compared to 2.6 million a year ago, an increase of 39%
- iPhone sales doubled in China.
- iPad sales grew to 22.9 million units compared to 15.4 last year, on a weekly basis 1.7 million iPads were sold compared to 1.1 million a year ago, a gain of 60%.
- Mac sales were down from $5.2 million in sales a year ago to $4.1 million sales this year, which is about 700,000 units.
- iPod sales were down from 15.4 million to 12.7 million.
- iTunes generated record results with revenue of $2.1 billion in the quarter. Apple had new all-time quarterly records for revenue from music, movies, and from apps
- The APP store had 2 billion downloads in December alone.
- The Apple stores had record revenue and Apple opened 11 new stores. The stores averaged 23,000 visitors per store per week.
- More Apple TVs were sold last quarter than ever sold before, eclipsing 2 million during the quarter. It was up almost 60% year-on-year.
Looking at the business it is obvious that iPhone and iPads are growing rapidly, iPad sales were actually hurt last quarter by a lack of supply. Had Apple been able to make more it would have sold more. Mac sales were down as new Macs were introduced too late in the quarter to help sales and the tablet craze is probably cannibalizing sales. PC sales for all vendors were down about 6% in the quarter and MAC sales suffered along with everyone else. iPad sales were down as more individuals use their cell phones as music players, reducing the need for a separate music player. iTunes and the Apple store continue to perform well.
Going forward, I expect to see iPad sales grow rapidly as they eventually become a common house hold item and as businesses adapt the iPad for their employees. iPhone sales will continue to grow as smartphones become more common; right now smartphones make up only 54% of U.S. cell phone users, leaving plenty of room for growth. In the fourth quarter, smartphones accounted for 45% of all international call phones shipped, again leaving plenty of room for growth. iPad sales will continue to slide, but iTunes will continue to show nice growth as music and movies become more mobile than ever. Mac sales will likely remain steady as Mac users upgrade as new products are released.
The wild card with Apple, is Apple TV. Apple has been very tight lipped about developments, but various rumors have indicated it is working on a game-changing product. Whether that is true or not, is anyone’s guess. But, the fact that Apple sold over 2 million Apple TVs last quarter hints at the sale rate it would have if it had a game-changing product.
In the technology device business, the refresh cycle is critically important, the latest and greatest becomes antiquated very quickly so Apple will have to remain the inventive company it has been if it wants to maintain sales.
Valuation – As previously mentioned, Apple had revenue for the quarter of $54.5 billion compared to $46.3 billion in the year-ago quarter, an increase of $8.2 billion year-over-year. On a weekly basis, revenue grew 27%. Earnings grew from $8.67 billion in the 4th quarter of 2012 to $13.81 billion in the first quarter of 2013. Earnings in the year-ago quarter were $13.87 billion, but again, last year had one extra week.
Despite the revenue growth and strong earnings, Apple sells for a P/E of 10.2 and has a P.E.G. (Price to Earnings Growth) of the unheard of 0.53. For comparison, I thought I would highlight a few other technology companies that sell for a higher multiple. Microsoft (MSFT) has a P/E of 9 and a P.E.G. of 1.13, Lenovo (LNVGY) has a P/E of 19 and a P.E.G. of 0.78, Cisco Systems has a P/E of 13 and a P.E.G. of 1.25, BlackBerry (BBRY) has a P/E of 16.4 but has no P.E.G, Google (GOOG) has a P/E of 23 and a P.E.G. of 1.20. Apple is cheaper than all of the above stocks and has stronger growth prospects than all of them with the possible exception of Google.
Bank of America Merrill Lynch estimates that earnings per share will increase by 20 % in 2014 and by 15 % in 2015. Goldman Sachs predicts revenue will increase 17 percent this year. Yet, the stock trades at 10 times earnings.
For the March quarter, Apple provided revenue guidance of between $41 billion and $43 billion compared to $39.2 billion in the year-ago quarter. That is revenue growth of 5% to 8%, as revenue grows, earnings usually follow. Quarterly revenue growth of 5% to 8% for a company with a P/E of 10 is not often found.
As I write this, Apple is within $7.00 of its 52-week low of $435.00, an undeserved price for a company performing as well as Apple. Some writers have stated Apple is losing market share, but if you look at the Verizon latest quarterly report, a year ago iPhones made up 55.8 % of Verizon’s overall smartphone activations, in Q4 this year, 6.2 million iPhones made up a whopping 63.2 %. Apple got stronger, not weaker, yet, Apple’s stock price is near a 52-week low.
Emotion drove Apple’s stock price up to $700.00, a price it did not deserve, now emotion has driven the price down to a price it does not deserve. Emotion can create bargains and Apple is a bargain.
Like cigarettes, Apple products are addictive. One of the things Apple has going for it, is the incredible loyalty users have for their Apple products. Apple has done this by designing products that are beautiful to look at and that perform exceptionally well. It has also created loyalty by having products that have their own ecosystem. Own a PC, it might be a Dell, it might be an HP, it might be a Gateway, it does not matter, have a file on one, it easily transfers to another. Have an Apple, getting the files over to a Window based PC is not so easy. Have an iPod and download songs from iTunes, no problem, want to play those songs on another MP3 player, big problem. Once Apple sells an iPhone, an iPad, or a Mac, it is on the way to having a customer for life. I know several people who have Mac computers, they love them and would never own anything else. The same is true of most iPhone users; they love the phone and look forward to the next upgrade.
Loyalty is a very difficult thing for most companies to develop. Apple has it and I believe that gives Apple an advantage over other companies. It can count on repeat customers and can expand its product line knowing loyal customers will be happy to purchase the latest Apple product. This loyalty applies to iTunes too. iTunes is the most popular music database and all those users who downloaded music are now downloading movies, TV shows and more. I believe the loyalty Apple consumers have for their Apple products will allow Apple to broaden its product line and sell more products. I think a key component and under appreciated business is the iTunes Store. As consumers demand more mobile media, Apple will be able to expand the store to offer more entertainment options to a public that seems in need of constant amusement.
All that cash. The 137 billion dollar question is what will Apple do with all the cash it has? Many critics have offered ideas for use of Apple’s cash; I will mention some of them.
- Buy Netflix’s (NFLX) -Netflix’s market cap is $9 billion, Apple could easily buy NFLX and incorporate the NFLX business into the Apple Store. Streaming movies may be the wave of the future and NFLX’s deals with various companies like Disney (DIS) gives it an advantage by having content for distribution before others do.
- Do a major stock buyback – Apple has bought back stock, but the benefits of it with all the stock options Apple and other technology companies reward their employees with has been limited. Apple could take just over $40 billion and buy back 90 million shares or about 10% of shares outstanding.
- Declare a special dividend – Apple could pay a special dividend of $25.00 a share at a cost of approximately 22 billion dollars.
The above are just a few of the ideas I have heard and there is no guarantee any of them will happen. What I do know, is that something will happen. Apple has a fiduciary responsibility to the shareholders and holding over $130 billion in cash is not serving the shareholders. Over $90 billion of the cash is overseas, which does complicate matters, but the fact is, Apple has to do something with the cash.
I have read reports that Apple is working with cable companies to get its set-top box distributed by cable companies. It is not clear to me what the terms of the deal would be, but it involves the cable companies distributing the set-top boxes and agreements with the content producers. I would think that this would involve some investment by Apple as the cable companies and content producers would need some financial incentive to aid Apple in their pursuit of television domination. Perhaps, Apple TV will be the use for some of Apple’s cash. During the Q&A of the most recent earnings conference call, Apple CEO, Tim Cook said this about Apple TV “I have said in the past this is an area of intense interest for us and it remains that and I tend to believe that the, there is a lot we can contribute in this space and so we continue to pull the string and see where it leads us but I don’t want to be more specific.” If something is of intense interest to Apple, I believe it is going to do something and it may require some use of its cash.
Action – I am a dividend growth investor and I prefer companies that pay a little better dividend than Apple does. However, at times I will buy stock in companies that present what I consider to be a trading opportunity. Apple presents that type of opportunity. With European markets down big (at the time of writing Monday) and U.S. markets down around 1% I will wait to see what the market action is tomorrow and then pick up a few shares of Apple. As previously stated, I do not intend to hold Apple forever, this will be a small position trade, which I will closely monitor. I do not like to have a selling price preset for a trade, I prefer to monitor the stock and overall market and sell when I deem it appropriate. I have sold stocks within 24 hours of buying them and have held some for more than a year. I expect Apple to rise back to a normal valuation once the negative spin on the company diminishes.
Additional disclosure: My son owns AAPL in an UGMA account.