We admit it, we’re a "lazy" Apple (AAPL) investor. We don’t rush to keep up with the latest news articles about AR, EV, or even its purported autonomous vehicle, nor do we eagerly anticipate the next third-party iPhone X sales report. As long-term investors in Apple, we think about the company differently.
We accept that the company is shrouded in secrecy, a cloak of its own creation, and that we’ll rarely know what the “one more thing” will be exactly, or how we can model it financially. Excel hates uncertainty and there’s no plug for “?”, so be it. Having said that, we can look at Apple and at least understand that it continues to evolve, from a company dominated by products to a brand that curates hardware and software to the masses. It has evolved into a company that’s simultaneously at the forefront of technology and marketing, which means on a broader scale, it’s really a funnel.
In a previous article addressing Apple Services, we stated:
“The company's products become the gatekeeper between consumers and vendors. On one side stands you the consumer, one that is demographically wealthier and statistically a higher user of Internet services, and on the other side are vendors (e.g., music, movie and media companies, software companies, goods and service providers such as Uber, Gilt, Airbnb, etc.). For each transaction funneled to you, Apple can potentially take a cut, and the profit margins on it are staggeringly high.”
That’s on the Services side. What will also be true in the next few years is how Apple will be one of the few companies to funnel technological innovation to the masses, and not just the “masses masses”, the “wealthy masses”, because we know Apple isn’t focused on ubiquity, it’s focused on catering to those willing to pay more for more.
Let’s just take a look at the iPhone X. Tim Cook stated in the most recent quarterly call, "iPhone X enables totally new experiences like unlocking your iPhone with Face ID, taking photos with studio-quality lighting effects, or playing immersive augmented reality games. We can't wait for people to experience our vision of the future.” Many tech bloggers and pundits pointed out that Samsung, Huawei, and other smartphone manufactures have, or will, introduce these features as well. How many people really know that? Maybe specific users of those products, but for the masses? Likely not. We’d contend that something like Face ID (or facial recognition on a mobile phone) doesn't filter into the collective zeitgeist until Apple introduces it, receives free and extensive media coverage, and rightly/wrongly receives credit for that innovation.
So it will go... on and on, for Face ID, Apple AR (wearable or what not), EV, autonomous EV, the next thing because that installed user base is already there, and waiting for the next innovation. Successful product execution has created a collective trust, and that trust has led to brand relevance and a premium brand. Many users will say that they may not know if Apple invented that technology piece, but they know if Apple makes it, then it's likely done right, and that's what counts. That's the essence of Apple's competitive advantage right now, and the 2017 results were a testament to that advantage.
Into 2018 My Friends...
Now a quick word on fiscal year 2017 as it recently wrapped-up. It was frankly fantastic. Now, many articles have already been written on Q4, so we'll spare you the details. At the end of last year, we set-out a few catalysts for why Apple's stock was undervalued and why the prices were set to climb higher...
Some near term:
- Stock buyback
- Services (Part 1 and Part 2)
Some longer term:
Many of those factors continue into 2018.
For the near term, we see Apple Services only strengthening as more product lines are introduced/adopted and more services are unveiled. Services registering $29B in revenue have already exceeded Apple's earlier target to become the equivalent of a standalone Fortune 100 company (i.e., generating over $28B), and continues to gain momentum.
A larger stock buyback via repatriated cash has yet to play out and of course will depend on the Republican tax plan passing. Recall that we said a large buyback would be the worst financial option, and that remains so. Net cash balances continue to grow, despite Apple's aggressive capital return program and that's before the Q1 holiday season where cash flows from operations increase substantially. Here's a chart based on Apple's most recent Form 10-K filing.
After recalculating cash balances as of 9/30, and assuming Apple pays a $15B EU tax liability/fine and pays down its debt using future cash flow (as opposed to repatriated cash), it would still have enough cash on hand to repurchase 20% of its shares. Thus, a 20% upside to the stock price remains (based also on the House’s tax reform plan) just based on the buyback possibility alone. Taking out Apple's debt entirely halves this calculation but also leaves a debt free company that can again releverage itself.
For 2017, we believe the stock rise has largely been based on an overall rising market, financial outperformance and an increasing multiple based on the market’s appreciation for the business (thank you Berkshire for that). We’ve exhorted Apple investors to simply buy and hold the stock as the company reinforces and expands its competitive advantages. Very few companies continue to combine mass consumer appeal with a luxury brand awareness, and even fewer at today’s low valuation.
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Disclosure: I am/we are long AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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