Morgan Stanley's Apple Analyst Recommends Adding To Holdings

Morgan Stanley’s Apple Analyst, Katy Huberty, has written two reports this week recommending owning Apple shares and adding to any positions in it. Huberty has multiple reasons that the shares should hit her price target of $110 and she has an upside case to $132 with the downside being $74.

This morning she estimates that value funds only own 9.8% of the float of Apple’s shares vs. 18.9% on average for the rest of the companies she covers.

She also believes that overall institutions don’t own enough Apple stock. Huberty estimates that the top 100 institutions only hold a 2.3% position vs. 4.5% at the peak two years ago and this is below Apple’s 3.4% weighting in the S&P 500.

She believes the Street is worried that the stock could peak around the iPhone 6 announcement/availability similar to the iPhone 5 two years ago. She doesn’t believe history will repeat itself since the larger screen iPhone will be launching when a large number of users can upgrade and China Mobile will add to demand since this is the first new iPhone available to them.

While Apple had announced its $45 billion dividend and share repurchase program in March 2012 it had not started to execute on it in any meaningful way until 2013. With the program now at $130 billion there is a belief that if the stock got hammered that management would be aggressive with buying back shares.

Huberty believes that consensus earnings estimates should trend up due to strong iPhone demand, $9 billion in revenue from an iWatch and acceleration of App Store services growth combined with new offerings.

She also points out that there have been a number of new hires to strengthen the company with the most visible one being ex-Burberry CEO Angela Ahrendts as head of Retail and Online Stores. It will take some time but she will need to reverse the stagnating or declining average revenue per store of the past seven quarters. Maybe all it will take is new products but it will be interesting to see if she is able to introduce any new “buzz” to them.

Gross margins are critical to the shares performance

Similar to what I wrote about on gross margins Huberty points out that they have stabilized over the past seven quarters. One reason was the iPhone 5c being priced higher than expected and she believes the iWatch and online services will be accretive to gross margins.

Stable gross margins is one of the strongest reasons I believe the stock won’t take a major hit since this is probably the biggest reason it did in the 2012/2013 timeframe. Gross margin peaked at 47.4% in the March 2012 quarter and when Apple announced 40.0% for the September quarter it looked like it was in free fall with no bottom in sight. Due to the bottom line impact gross margins have investors fled the shares. Now that it looks like they can hover in the high 30%’s area that concern has moved to the back burner.

Valuation is more than reasonable

Huberty estimates fiscal 2015 and 2016 EPS of $7.56 (consensus at $7.03) and $8.60 (consensus at $7.86), respectively, with share counts dipping down to 5.814 and 5.533 million, respectively. That translates to PE multiples of 13.4 and 11.7 before any of Apple’s cash and investments are taken into account (beyond what would be needed to pay the dividend or any stock buybacks that have not been executed).