onsdag 12 november 2014

Why you should delay your purchase of Apple shares

A more detailed model can reveal surprises regarding likely patterns of growth and profitability.

This time it didn't. Apple still seems about reasonably valued. I would nevertheless hold off buying their shares until Apple or the market stumbles - and you can buy Apple shares more cheaply.

The exercise below is still worth going through to build your own model of Apple or other companies. The difficult balancing act is to choose how much information to include, to make the model informative and useful without making it inaccessible.

Refining the Apple model

Enhance the Apple model with forecasts for the individual product categories, to make total sales forecasts more robust and more closely linked to reality.

Get Apple's latest publicly filed 10K report. Flip to page 29 and check the product break-down. Start building a model for total sales based on the various product areas. Calculate your own Average Selling Prices (ASP).

iPhone, #125046150257169219
iPhone ASP629607603
iPhone sales7869291279101991
iPad, #583107103367977
iPad ASP531450445
iPad sales309453198030283
MAC, #181581634118906
MAC ASP127913151274
MAC sales232212148324079
iPod, #351652637914377
iPod ASP160167159
iPod sales561544112286
iTunes, s/w and svcs: sales128901605118063
Accessories (incl 3rd party)514557066093
Total sales$156,508$170,910$182,795

Read the footnotes on the following pages in the 10K, to see what Apple is saying drove the changes in unit sales and dollar sales. Then make some initial forecasts based on your best guesses on what might drive sales going forward, or by just intelligently extrapolating previous trends.

I imagine increased competition on phones will make unit sales growth gradually drop toward the industry average (which itself is likely to drop toward global GDP). I think the iPod form factor will disappear and I think Apple will struggle with both unit growth and ASPs for iPads and MACs due to Apple being less unique, less cool and being much larger. Apple is becoming a BMW instead of a Ferrari or Porsche.

I'm modelling growth gradually dropping for iTunes too, and GDP-like growth for accessories. Apple enjoyed a first mover advantage and does have a faithful installed base, but competition is heating up and it's becoming easier every day to buy digital content from any source.

Use what you know about the last ten years' change to consider risks in the future

Once again, Apple was unique for a while, for longer than most consumer companies but it won't last forever. Just think about how unbeatable the combination of Nokia, Sony, Motorola, Blackberry seemed in 2007 before the iPhone. Going forward, Xiaomi, HTC, LG, Lenovo, Google, Microsoft, Motorola and yet unknown companies are ready to give Apple a run for its money in phones and computers.

I know I should include forecasts for Apple Watch, as well as unknown future products. On the other hand I think new products will basically replace, cannibalize and more or less just lead to a continuation of previous trends anyway. The Watch, e.g., is likely to be an inconsequential niche product in my view, similar to the iPod.

Refine the product category model, with unit growth, sales growth and forecasts like this:

iPhone, #125,046150,257169,219186,141201,032215,104228,011239,411
unit growth20.2%12.6%10%8%7%6%5%larger grows slower
iPhone ASP629607603603603603603603inflation vs novelty/uniqueness
iPhone sales$78,692$91,279$101,991$112,190$121,165$129,647$137,426$144,297
iPad, #58310710336797764,57861,34958,28255,36852,599
unit growth21.8%-4.3%-5%-5%-5%-5%-5%less favored form factor
iPad ASP531450445441437432428424
iPad sales309453198030283$28,481$26,787$25,193$23,694$22,284
MAC, #18158163411890619,09519,28619,47919,67419,870
unit growth-10.0%15.7%1%1%1%1%1%
MAC ASP12791315127412741274127412741274no particular guess
MAC sales232212148324079$24,320$24,563$24,809$25,057$25,307
iPod, #3516526379143778,6265,1763,1051,8630
unit growth-25.0%-45.5%-40%-40%-40%-40%-100%form factor disappearing
iPod ASP1601671591511441361300sales necessary
iPod sales561544112286$1,303$743$423$241$0irrelevant anyway
iTunes, s/w and svcs: sales12890160511806319,86921,45922,96124,33925,556
unit growth24.5%12.5%10%8%7%6%5%competition, Apple less unique
Accessories (incl 3rd party)5145570660936,3986,7187,0537,4067,776
unit growth10.9%6.8%5%5%5%5%5%
Total sales$156,508$170,910$182,795$192,561$201,434$210,086$218,162$225,220
sales growth9.2%7.0%5.3%4.6%4.3%3.8%3.2%
Current forecast in model155,970170,910182,795193,763203,451213,623224,305235,520

Finally, compare the bottom-up forecasts for sales and sales growth with top-down guesstimates from earlier. The new forecast is less optimistic than before, and I trust that more than my first guess.

I have no new information on gross margins per product. You could guess what the margins are, but I don't think that would add anything useful to the model at this point. However, on page 82 in the latest 10K, the quarterly total gross margins for 2013 and 2014 are listed. If the level and trend look stable we can use that for the entire company. Just throw the quarterly numbers into a spreadsheet like below.

Notice that there were a lot of launches in Q4 2014 and Q1 2015 (including the Apple Watch). That probably means I should upgrade my sales forecasts for 2015 compared to what I have in my model now. I bump up sales growth for iPhones to 13% (previously 10%) in 2015. In addition I change iPod unit growth from -40% in 2015 to 0% to account for Apple Watch.

Know what you don't know

Margins, however, might actually fall, due to the cost of several launches and fine tuning production. I keep them stable nevertheless since I really don't have any idea.

Quarterly data from page 82 in the 10K report:

Q1 2013Q2 2013Q3 2013Q4 2013Q1 2014Q2 2104Q3 2014Q4 2014
share of year sls31.9%25.5%20.7%21.9%31.5%25.0%20.5%23.0%
quarter "strength"-0.4%-0.5%-0.2%1.1%relative strength of quarter
Net sales$54,512$43,603$35,323$37,472$57,594$45,646$37,432$42,123
growth5.7%4.7%6.0%12.4%y/y growth rate
Gross margin$21,060$16,349$13,024$13,871$21,846$17,947$14,735$16,009
margin %38.6%37.5%36.9%37.0%37.9%39.3%39.4%38.0%
y/y margin change pp-0.7%1.8%2.5%1.0%y/y chg in margin
Net margin$13,078$9,547$6,900$7,512$13,072$10,223$7,748$8,467
margin %24.0%21.9%19.5%20.0%22.7%22.4%20.7%20.1%
y/y margin change pp-1.3%0.5%1.2%0.1%y/y chg in margin

I think margins look stable enough for now to simply extrapolate them at the current level. Competition puts pressure downward, but economies of scale act as a positive counterweight.

Link the new bottom-up model for sales into the main forecast sheet. At the same time you have to change the growth inputs on row 22 to a calculation of what's going on on row 5 (sales).

The model didn't change that much from earlier, but the confidence in it has increased somewhat. You now know what's happening to the various product categories, and you have a feel for ongoing launches, as well as quarterly growth and margin progression.

The value of Apple's stock still comes out around 107 USD per share.

Cost of sales106,606112,258139,507145,716151,872157,670162,700
Operating profit18,54034,21055,76050,15553,48356,98259,51862,03264,40166,455
Income tax(13,118)(13,973)(14,815)(15,475)(16,128)(16,744)(17,278)
Diluted nr of shares6,521,6346,122,6635,877,7565,642,6465,416,9405,200,2634,992,252
Earnings Per Share5.686.457.177.818.479.169.85
Revenue per share26.229.933.436.439.542.745.9
Market cap at current share price667,370,267640,675,456615,048,438590,446,501566,828,641544,155,495
sales growth9.6%7.0%7.5%4.5%4.2%3.8%3.2%
tax rate-26.2%-26.1%-26%-26%-26%-26%-26%
Share count evolution-6.1%-4%-4%-4%-4%-4%
cost of share purchases at current price26,69525,62724,60223,61822,673
Buyback cost as proportion of earnings63%58%54%50%46%
Dividends per share DPS1.641.822.002.192.392.602.81
Cost of dividends and equiv.10564111261175612352129521353014052
Shareholder's equity47,79076,620118,210123,549111,547115,263121,328129,678140,187152,638
Long term debt16,96028,987
Equity per share18.918.219.621.523.927.030.6
Return on Equity = Earnings/equity54.2%54.5%31.3%32.0%37.8%38.2%37.8%36.7%35.1%
Net income14,01025,92041,73037,03739,51042,16744,04345,90447,65649,177
Depreciation and amortization etc1,0301,8106,55713,52015,90017,09117,85218,60619,31619,933
Deferred taxes1,4402,8704,4101,1402,3502,4422,5512,6582,7602,848
Other, net working capital9031,170(1,740)2,2502,8601,0891,1371,1851,2301,270
Total operating Cash Flow17,38331,77050,95753,94760,62062,78865,58368,35370,96373,227
According to Apple53,66659,71362,78865,58368,35370,96373,227
Financing including stock repurchases(16,379)(37,549)(38,450)(37,979)(37,553)(37,148)(36,726)
TOTAL CHANGE IN CASH3,513(415)3,8296,1828,47310,63612,582
Free cash flow excluding dividends and Buybacks42,27944,16046,02647,78349,308
End of year equity115,263121,328129,678140,187152,638
Discount rate, required return7%7%7%7%7%7%
Discount factor107%114%123%131%140%
Present value of cash flow39,51338,57137,57136,45435,156
Sum of present value of cash flow (Net Present Value)39,51378,085115,656152,109187,265
End value of business after last cash flowCF yield requirement6%6%6%6%6%6%
CF multiple16.6716.6716.6716.6716.67
End valueNext year's CF times warranted end multiple736,008767,102796,391821,797862,887
Discounted end value (End value divided by discount factor)687,858670,017650,092626,945615,226
Sum of NPV (disc CF stream + disc end value)727,371748,101765,748779,054802,492
Discounted cash flow value per share (end of 2014); sum of NPV divided by nr shares today (eof 2014)119122125127131
Other approaches
Required return on equity7%7%7%7%7%
RoE next year38.2%37.8%36.7%35.1%
Warranted equity multiple546%540%525%501%
Warranted value629,188655,769680,806702,525
Discounted warranted value588,026572,774555,741535,953
per share (today's number of shares)96.093.590.887.5
LT market PE105PracticalHidden assumptions
DCF125CorrectExplicit but sensitive
RoE91Crude but correctVery rough measures of Eq and rRoE

The next logical step would be to forecast sales for individual iPhone models, since iPhones make up more than half of Apple's sales. That information could be used for forecasting individual quarters tro possibly speculate on share price movements around company earnings presentations. I wouldn't recommend that. I actually think it's mostly a waste of time. Apple is already managing its product launches the best way it can, which produces a quite smooth yearly growth trend that gradually tapers off due to GDP growth, industry growth and competition.

I think, once again, this basic model proves that Apple is quite boring, very big, neither obviously expensive, nor cheap as long as nothing "unexpected" happens. Whether a surprise is likely to be positive or negative is anybody's guess. My personal estimate is that a recession, a product failure, competition, a stock market fall, a natural disaster, increasing risk aversion and required return or something similarly negative is more likely than Apple suddenly boosting its growth or margins. Sure, Apple could launch the iCar or iGroceries, iHotels or whatever, but I just don't see it and wouldn't advise betting on it.

Buy Apple shares later

If you feel you just have to buy Apple shares, do yourself a favor and wait for a stumble, a product miss or a stock market correction. Then buy. Don't buy Apple shares now, right when both Apple and the market are at their respective peaks of the game.

3 kommentarer:

  1. You should also ask yourself why Apple should trade outside its recent 3-month, 6-month or 12-month stock price interval in the near future.

    FYI: Apple's 12-month interval is 70-110 USD/share

    What new information has been unearthed during the last 12 months (or what unexpected information do you expect to be announced soon) that warrants either the actually realized 60% appreciation or venturing outside the stock price interval (of 70-110) set by hundreds of thousands of profit seeking investors?

    Remember that Apple's sales and earnings and product launches developed almost exactly as expected during the last 4 quarters. The only thing that "happened" was time passing, which means the stock price warrants upgrading by the annual discount rate - which we have set at around 7%.

    The other +50%-points are unexplained by fundamentals, meaning a return to a share price of 70 is just as normal as staying at the current high end of the range of 110 USD/share.

  2. What's your opinion on buying Halliburton, SeaDrill or Transocean shares right now? Both just got absolutely hammered and are probably undervalued.

    1. Hi, and thanks for asking.

      I never was responsible for investments in oil services. One of the other three PMs covered the companies you mentioned.

      However, we were heavily SHORT them in August and beginning of September but had to cover them when the fund was closed down (last date with any positions left was Sept 8, 2014)

      At this point with oil prices crashing I guess you could make a good point for buying with bloods on the street, but I don't have any specifics. You're on your own here unfortunately - unless you have some specific NUMBERS you want to run by me.

      Take care