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Take another bite of Apple

Apple is launching new products and breaking into growth markets, yet its shares still trade cheaply
November 5, 2015

There are few truly great companies, and even fewer whose shares offer significant upside for investors. We reckon Apple (US:AAPL) is one of them. The consumer electronics titan is growing quickly, launching innovative products and breaking into new territories. Yet strip out the cash from Apple's market value and its shares trade at an irresistible nine times forecast earnings for this financial year. We think that deeply undervalues the company's stellar track record, strong growth prospects and its unique ecosystem of hardware, software and services.

IC TIP: Buy at $121.2
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points
  • Strong sales and profit growth
  • New products and services
  • Expanding fast in emerging markets
  • Low share rating excluding cash
Bear points
  • Economic slowdown in China
  • Falling sales of iPads

Analysts feared that economic slowdown in China and the release of the large-screen iPhone 6 and iPhone 6 Plus in September 2014 would make year-on-year growth a challenge in the final quarter of Apple's 2014-15 financial year. But revenues rose in all five of Apple's territories, reflecting record iPhone sales and all-time high sales of both Mac computers and services. Moreover, full-year sales rose by more than 70 per cent in Greater China - Taiwan, Hong Kong and mainland China - and by more than a tenth in the key 'Americas' region. That was driven by a 52 per cent rise in iPhone revenues to about $155bn (£101bn); also the higher average selling price of the latest iPhones - up more than 10 per cent to $670 - helped widen the group's gross profit margin by 1.5 percentage points to 40.1 per cent.

Several factors should support further gains. More consumers are switching from Android-powered phones to iPhones and around 65 per cent of iPhone owners are yet to upgrade to iPhone 6 or the new iPhone 6s. In addition, a large population remains untapped: more than half of those who bought iPhone 6 devices in China in the latest quarter were buying their first iPhone. As consumers join Apple's ecosystem, many will buy apps and games on its App Store, sign up for its Apple Music streaming service, use its contactless Apple Pay system and buy headphones and accessories, fuelling sales growth across the group.

 

 

A raft of new offerings should also attract users. The group launched its Apple Watch wearable computer in April, recently rolled out a revamped Apple TV set-top box, and a large iPad Pro tablet is on the way. Apple should also benefit from the roll out of high-speed wireless infrastructure in China and India and from the former's burgeoning middle class, whose number is predicted to quadruple to 500m by 2020. Accordingly, Apple plans to target smaller Chinese cities, which house the bulk of the nation's population, by expanding from 25 retail stores to 40 within the next year. There's also the growing enterprise business, where full-year sales rose 40 per cent to $25bn as Apple partnered with Cisco and collaborated with IBM.

And there are long-term growth drivers, too. For example, Apple recently introduced a new upgrade programme that charges customers between $32 and $37 a month over two years in return for the latest iPhone, an annual upgrade and damage insurance. That should broaden the market for iPhones by making them more affordable. It also gives buyers the freedom to choose their mobile carrier, and should speed up the replacement cycle, or how long consumers wait before upgrading their phones.

Those factors underpin management's guidance of constant-currency sales growth of up to 11 per cent in the first quarter of 2015-16. Broker Drexel Hamilton expects Apple's operating profit to rise 5 per cent this financial year, sending EPS up 10 per cent to $10.13 (see table). It also thinks that the launch of iPhone 7 and growing adoption of Apple Watch will accelerate growth next financial year. Yet strip out cash of $26.26 a share and Apple's shares trade at an enticing nine times forecast EPS for this financial year, much less than the average for the US S&P 500 index. Apple also plans to return $200bn to shareholders between April 2015 and March 2017, including $140bn in share buybacks.

One concern will be continued declines in iPad revenues, as MacBook laptops and larger iPhones cannibalise demand for the tablet. But robust sales of other products are likely to compensate.

APPLE (AAPL)
ORD PRICE:$121.20MARKET VALUE:$676bn
TOUCH:$120.88-$121.2012-MONTH HIGH:$134.54LOW: $92.00
FORWARD DIVIDEND YIELD:2%FORWARD PE RATIO:11
NET ASSET VALUE:$21.41NET CASH:$150bn

Year to 26 SepTurnover ($bn)Pre-tax profit ($bn)Earnings per share ($)Dividend per share ($)
201317150.25.71.63
201418353.56.51.82
201523472.59.21.98
2016*25676.710.12.17
2017*27884.011.42.38
% change+9+10+13+10

Beta: 1.07 £1=$1.54

*Drexel Hamilton forecasts; dividend forecasts - Bloomberg consensus