Apple: Armageddon Didn’t Materialize

Josh Arnold

You’re getting paid to wait!!!!

Apple’s (AAPL) epic decline over the last several months has erased roughly $250 billion of market capitalization from what was briefly the most valuable company ever in nominal terms. For some perspective on the matter, that is greater than the entire current value of Microsoft (MSFT); it is as though a company the size of Microsoft has been wiped from the face of the Earth. The endless debate of whether or not the selloff was warranted continues to rage but putting the emotion and noise aside, we need a way to value Apple shares. One of my preferred methods is that of free cash flow yield. I use the operating cash flows of a company and divide it by the market cap in order to understand how much cash the operating activities of the business actually generate in relation to the business’ price.

For this article, I pulled data from the company’s Qs and Ks from the SEC website and then computed the average market cap for the years in question. For instance, I would use the actual market cap observed at quarter end for each data point and then compute the average of those four to get the average market cap for the year, which was then used as the denominator in my FCF yield calculation. Operating cash flows are pulled directly from the financials.

First, this graph shows the historical relationship between Apple’s FCF and its stock price. Keep in mind that this data is shown per Apple’s fiscal years and not calendar years.

(click to enlarge)

What we see here is that the stock price has moved in virtual lockstep with the company’s ability to produce FCF. This is to be expected and with the exception of the stock price moving ahead of FCF in the late 90s and again in 2008, this relationship has held pretty steady. What’s interesting is that the enormous growth in the stock price in the last four years has been more or less right in line with FCF growth.

We can look at this data in another way; I have computed the estimated historical FCF yields for AAPL.

(click to enlarge)

We see that during 2008 to 2010, Apple hovered around 8 to 9 percent FCF yields. However, starting in 2011, Apple’s FCF yield soared about 350 bps over 2010’s number to yield nearly 12%. FCF yield moderated in 2012 with the number back below 10%, but still elevated compared to 2008 to 2010. This means that the market has been unwilling to pay as much for Apple’s operating cash flows as it once was. There are many reasons why this could be the case but the perception that Apple is out of its growth phase is probably chief among them.

Another thing to notice that I think is more important is my estimation of 2013 FCF yield. I derived this estimate by using Apple’s current market cap of $402B and reducing 2012’s operating cash flow by 10%. Basically, I am pricing in that Apple will produce 10% less cash this year than it did last year. This may prove to be conservative or optimistic; only time will tell. However, the result is interesting. By my calculations, Apple is currently trading with an FCF yield of over 11%. This is certainly high by historical standards, as we can see. This means that some pessimism is priced into Apple shares currently, which could offer some upside if Apple can deliver only negative 10% operating cash flow growth this year.

Given the iPhone refresh cycle coming this year and whatever Apple has in the works that we don’t know about yet, I think negative 10% growth is something Apple can reasonably beat. Whether I prove correct or not is anyone’s guess, but the point is that the pessimism is already priced into shares and the downside to Apple’s operating cash flow will have to be enormous to justify further losses. All Apple has to do is step over the low bar of negative 10% growth and the stock will still have an FCF yield of 11% in 2013. As a side note, if Apple can produce negative 10% growth in its FCF this year, and the market again prices Apple’s cash flows with a yield of 9% instead of 11%, that implies a market cap of $500B, or roughly 25% up from where we are today.

Add in the launch of the less-than-thrilling Samsung Galaxy S4 and it’s clear that Apple’s competitors don’t have the ability to out-innovate the Cupertino powerhouse that some may have thought. The S4 is more of a refresh than a new, groundbreaking innovation and the stock price has responded as such since the announcement. The fact is that Apple still has one of the most recognizable brand names on the planet. It is enormously profitable despite declining margins (mainly due to iPad Mini), and new products such as the iWatch, a larger iPhone and perhaps even a cheaper iPhone aimed at emerging markets will continue to drive record profits in the years to come. Let’s not forget that Apple also has the iTunes platform that drives a recurring revenue stream that is ever-growing and can be adapted to become a payment facilitator or any number of other services Apple wishes to provide.

The fundamental picture has never been so bright for a stock that is so unloved by investors. With the new Galaxy proving to be of little threat to Apple’s innovation dominance and cash flow yields near their highs, now seems like a great time to get long Apple. Couple this with the near-certainty of an increased capital return plan for Apple’s cash balance, and even if it takes some time for shares to appreciate, patient investors will be handsomely rewarded as they are paid to wait.


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