Apple’s shares were up $3.51 on Monday to $133, which is a market cap of approximately $750 billion (up over $20 billion just on Monday) and the shares would have been $931 if they had not split 7 for 1. One of the main reason Apple’s share were up for the 13th out of 15 days this month was due to a positive Barron’s article that said the company’s shares should reach $160 in the next year (about a $920 billion market cap). While I am also positive on Apple and developed an analysis on how Apple could get to a $1 trillion market cap a few years out Barron’s analysis needs some closer scrutiny. (Note that I own Apple shares and have sold Calls against them).
US cash generation could limit the dividend increase
Barron’s is expecting a big increase in Apple’s dividend to be announced in April especially since the current 1.5% yield is “undersized”. The concern I have with this assumption is that Apple is on track to pay out $11 billion or more in dividend payments this year, which has to come out of US generated cash. In fiscal 2012 and 2013 the company generated $13.9 and $13.3 billion in US cash, which did increase to $20.5 billion in fiscal 2014.
Since stock buybacks also have to come from US generated cash or debt and I believe Apple’s management and Board will take a multi-year outlook on how much to raise the dividend, how much US cash the company can generate and how much debt they are willing to take on for buybacks (and not plan for a tax holiday to bring back international cash since this is determined by politicians) this could mean Apple decides to increase the dividend in the low to at best mid-teens percentage which could disappoint investors.
Apple has 89% of its cash and investments overseas
Barron’s is correct that Apple has $30 in cash and investments per share but doesn’t bring up that it has $6 in debt per share. Of the $30 almost all of it is overseas at 89% or $27 per share. Since the majority of debt should be subtracted against the US cash Apple actually has a negative US cash per share of almost $(3).
Apple includes stock compensation in its income statement
One item that I agree with Barron’s is that Apple does not try and juice its earnings by providing non-GAAP numbers. It gives stock compensation expense in its press release more as a footnote than as a focus item to get investors to use a higher net income or EPS number. This is one reason I like to use free cash flows over a multi-year timeframe when analyzing company valuations. I also believe the cost of acquisitions should be included in free cash flows as this is essentially another form of research and development.
Free cash flow significantly exceeds earnings but the gap will shrink
Apple generates a tremendous amount of free cash flow that easily exceeds its earnings. As Barron’s points out this is because it sells products so quickly that it receives payments from customers before it has to pay its vendors (I calculate that it has a negative 15 days cash conversion cycle). However as growth slows and if it can’t stretch payments to its vendors longer than it currently does (59 days in fiscal 2014 vs. 47 in fiscal 2013) the gap between free cash flow per share and EPS will shrink.
I agree that Apple’s shares may deserve a higher PE multiple but not a market multiple
Barron’s points out that Apple’s shares trade at valuation multiples below the S&P 500 and below many other tech and non-tech companies even though it has better growth prospects. It cites that if Apple’s shares traded at the market’s 17x forward earnings estimates then the stock would be at $160 and that “considering Apple’s understated earnings, cash hoard, avenues for growth and history of beating expectations it’s time for the stock to carry at least a market valuation, if not a premium.”
While Apple’s multiple could move higher there are a number of valid reasons it could stay below a market multiple with the two biggest being the law of large numbers and lower growth rates when we get to the December 2015 quarter. The Street is expecting EPS to grow 7% and 6% in fiscal 2016 and 2017, respectively. Those are a long ways off but I do agree that the company’s growth rates should slow. And I don’t think an Apple car should be part of any valuation assumption.
Barron’s is using aggressive Watch estimates
Barron’s cites a previous article that uses JP Morgan’s Apple analyst Rod Hall’s Watch estimates of 26 and 55 million Watches to be sold in calendar 2015 and 2016, respectively, generating almost $11 and $23 billion in revenue. I’ll agree that if Apple can hit these numbers then it will be a big success and help drive the shares towards if not to Barron’s $160 price target. However, since the Watch has yet to become available (but Apple’s PR machine is revving up) I’d be more conservative in what to expect. If the Watch falls flat, except for the first wave of people that are going to buy it no matter what, it will be up to the iPhone 6 to make up for any disappointment.
Shares are in very over-bought territory
While this is mainly a short-term concern Apple’s shares are becoming more over-bought than they were just a few days ago. The NASDAQ has also been up 9 days in a row so at some point in time, which looks like it should be sooner rather than later, Apple’s shares should pull back.
