Apple stock has fallen from $705 to as low as $632 in the last two weeks, which makes it very attractive from a valuation perspective. The old adage “Buy Low Sell High” applies here but it feels like when it comes to Apple, investors lose confidence in the stock when it begins to fall. Conventional wisdom would say, if you like a stock at one price and the fundamental remain in tact, then you are really going to like it 10% lower. What is wrong with Apple right now?
Earlier in the week, an analyst came out with a “Neutral” rating. This action got a lot of media attention - but it should not have. Nomura “initiated with a Hold” which means the analyst began writing research on Apple and could not recommend to investors whether to buy or sell the stock. First, what value is a stock report if it doesn’t recommend an action, particularly if one is say the 60th analyst to write on the stock? Second, the Nomura analyst placed a $710 price target on the stock, which is 10% upside from here. In most circles, that would quality as a buy. Third, of the analysts with “Buy” ratings on the stock, their average price target is around $750, not far from the “hold” analyst. Between the lines, the Nomura report “walks and talks” like a Buy.
Investors are worried about iPhone5 sales. First, the concern was that Apple only sold 5M on the first weekend. But, 5M was a blow out by any criteria. Second, the concern has become that issues at Apple’s manufacturer and assembler, Foxconn, suggest that Apple will be limited in its ability to supply iPhone5s in the December quarter. It is a legitimate concern that supply could be limited in the December quarter, but, remember, we are only eleven days into the December quarter and Apple has a strong track record of consumers waiting until they can get the products they want. Every quarter that the market dings Apple for consumers waiting for the product until the next quarter, Apple produces a monster subsequent quarter. As I have written in a couple articles, Apple is beginning to shape up into a stock that can’t be followed quarter by quarter, but needs to be followed on a longer-term basis. Product introductions and, even more relevant, anticipated product introductions create big quarterly swings as consumers are eager to wait for the newest thing, especially when it comes to Apple.
Even Jim Cramer has shied away from technology investments in the fourth quarter, which can have an impact on stocks. Although he did point out that the strengths currently are not in industrials, but rather with the consumer. Apple is in the sweet spot of consumer. Cramer’s top picks in technology now are Google and Amazon, but one could surmise that there are more Apple products on holiday gift lists than items from Google and Amazon. And, remember, Google doesn’t make any money on Android, and its estimated margins on the Goolge Nexus are thin. The Google Nexus 7 retails for $199 but its components and assembly cost $184. Amazon has admitted that it doesn’t make any money on the Kindle Fire, but on the content that the Kindle Fire offers. Meanwhile, Apple’s gross margins are estimated to be 51% for the iPad (iSuppli) and 70% for the iPhone5 (iSuppli).
Apple has a lot of momentum going into the December quarter with its iPhone5 and the new iPods. Demand exceeds supply. Remember, this is a good problem and certainly better than the opposite. Right now, the wait time for an iPhone5 is 3-4 weeks. Even the new iPod Touch is not immediately available on the website. Again, it has been past experience that consumers are willing to wait for these products. Just think about it, if your teen has an iPod or iPhone on their holiday gift list, are you really going to risk getting them an Amazon Kindle Fire? Doubtful. Gene Munster at Piper Jaffray did another survey recently and found that 40% of teens have an iPhone, and up from 11% in the Spring of 2011. Moreover, 72% of those that have a tablet, have an iPad. In Seven Reasons iPhones and iPods Boost December quarter – Quantified, I present the data on how pent-up demand affects Apple’s sales and earnings. iPhone unit sales have increased 41%, 66% and 117% over the quarter previous to the product release. Notice as well that each successive product release gets stronger. What is particularly interesting is that Apple received a lot of flack for the iPhone 4S because it was just considered an “upgrade” as opposed to a new product, and the iPhone 4S units sold increased 163% in the first full quarter since its release over the quarter the iPhone 4 was released.
Another concern has been the “slowdown” in China. China is quickly becoming a very important market for Apple as it accounts for over 20% of Apple’s sales. The World Bank reported that China’s GDP may decline from 9.3% last year to 7.7% this year, and rebound to 8.1% next year. To put this in perspective, 8% GDP growth is good. Back in December 2008, when US GDP growth was -8.9%, Apple’s revenues to North America increased 13.9% year over year. And the US is a mature market for Apple, not an emerging market as is China.
But, more important to Apple than China’s overall GDP growth, is the growth in China’s middle class, the growth in the spending power of that middle class, and the appetite for products like Apple’s by the middle class. By these criteria, China still holds up. Chinese middle class will be 45% of the population by 2015. They are young, live in cities, spend don’t save and have a penchant for western luxury goods. Today, there are only five Apple retail stores in China producing such strong revenues. And, the iPhone5 will be available at China Telecom and China Unicom in December with expectations that a chip will be developed for China Mobile in the upcoming months. The potential for Apple in China remains strong.
Bottom line, there are legitimate concerns about Apple being able to supply enough iPhone5s to meet demand. If it proves to be true and enduring, it most likely pushes demand out another quarter, but it is too early in the quarter to know for sure. If Apple is having difficulty at Foxconn with the iPhone5, it most likely spills over into expectations about an iPad Mini launch, and will delay that as well. Again, It is early in the quarter and there are still 74 days until Christmas. So, the most likely outcomes are either Apple ramps up supply in time for the holidays or consumers do what they have previously done, just wait. Earnings will come in this quarter or the subsequent quarter.
Investors should look at the long-term prospects of Apple, not in context of losing Steve Jobs, but in context of the competition and in context of profitability and innovation. Apple is leading the market in the fastest growing segment, tablets. Apple owns a quarter of the market in smartphones (the saturation and demise of which has been prematurely declared), and Apple is due for an upgrade to iMacs and Apple tvs soon. Look at the long-term price chart of Apple in context of other periods when noise in the market shook investor confidence and see that Apple continues to push through these periods. At $630, Apple trades at less than 10x FY’13 earnings (excluding cash), is growing conservatively at 20%, and has $117B in cash and investments on its balance sheet. Apple remains a better buy today at $630 than it did two weeks ago, certainly. Invest for the long term.
