Apple, Inc. (AAPL) has been the big talking point in the markets of late, having become the largest public company in the world by market cap. This week's earnings report has had people talking even more, with the sharp decline in the stock after the release of their Q1 results.
Based on all this talk, we decided to drill into a discounted cash flow ("DCF") valuation to find out just what the monolith that is Apple, could actually be worth, without getting caught up in all the market fever.
For those who don't know or may need a quick refresh, a DCF valuation works on the principle of projecting the expected future cash flows available, in this case to equity holders, then discounting these cash flows into today's terms considering risks and expected returns. Basically, it's the intrinsic value of the company's equity.
We perform two DCF valuations on AAPL to see if it's a case of apple pie or rotten apples, those being a:
- Base case - based on market and our estimates today of AAPL; and
- Doomsday case - based somewhat on what we have seen happen to Research in Motion, (RIMM).
Base Case Share Value
So we begin with the base case. The base case relies on 21% growth in revenues this year, which stabilizes down to a 3% long-term growth rate in the expected scenario. At the same time operating margins level off to 27%. This is somewhat in line with analyst expectation.
We also increase and keep working capital expenditures quite high, as we are expected they will be needed for Apple to not let competitors get ahead. The WACC is set at 10% in the expected scenario, the common WACC associated with Apple and the industry.
Finally, the present value cash flows determined by the DCF are only those related to the operating assets. Apple has a significant amount of non-operating assets/capital that needs to be included in the valuation. That being excess cash, short-term investments and long-term marketable securities. These are all either cash or tradable investments that should be easily saleable. For this exercise we keep them at balance sheet value, however, some may feel it more prudent to discount the long-term securities somewhat. We note that AAPL claims almost all marketable securities are of investment grade.
As can be seen in the table below, there is in excess of $137 billion in excess cash and marketable securities. This capital as mentioned is not a part of the business operations (i.e. non-operating capital), and should separately be included in the DCF in our opinion. We have also removed the earnings from these holdings from our DCF valuation by assuming an income of 0.4% a year on their value. The incomes were removed due to not being a part of regular operations, i.e. operating capital. Note, Apple has no debt, therefore there is no need to net and debt out of the calculation.
The below table shows our analysis of the base case at the target scenario, providing a value for AAPL of $619 per share. Indicating the current market price of around $450 is good value. The table also shows a sensitivity analysis of the value per share should the long-term growth and WACC be adjusted, ranging from a price of $539 to $752 per share.
To see the DCF spreadsheet of the base case, click here.
The next scenario, the doomsday case, we base on Apple being hit hard with a massive fall in market share, as occurred to RIMM. This scenario is just to highlight the risks, should a similar fate befall Apple. We try to model it with what has occurred to RIMM, but we don't have the full picture yet on how it has affected them in the latest financial year, so we will have to make assumptions here. We model the decline beginning now and unfolding over the next couple of years.
Firstly, we keep to a growth in sales of 10% for the current financial year, albeit lower than expectation. The following year, as occurred with RIMM, there is a 7% drop in sales, followed the next year in 2015 by an even more significant decline of 30%, around what is expected for RIM this year. Correspondingly, operating margins drop significantly from 32% to -7% in 2015. We are unsure exactly what has happened to RIM's margins this year, but indications say it will likely be somewhere around this level.
Finally, after the 2015 decline, we expect growth to stabilize and margins to improve to a healthier level, so we finish with a long-term growth of 2% and operating margins of 15%.
All other assumptions are kept the same as in the base case model. We also add the cash and marketable securities to the value, as in the base case scenario. This provides us with a final value of $224 per share. Around a 50% decline in value on today's $450 market price, which would likely be even more in reality, as with Apple no longer having the same sentiment it has today, and becoming a significantly smaller company, many funds would have to pour out of it, further decreasing the price.
The doomsday case should be heeded by any investors who see this as being a scenario that has a decent possibility of occurring.
To see the DCF spreadsheet of the doomsday case, click here.
Based on our base case DCF valuation and the assumptions used, it appears there could still be plenty of value in AAPL at today's current price.
Our doomsday DCF illustrates the significant decline that would occur to AAPL should a similar fate befall them as occurred with RIMM. Investors who see a potential slip from Apple should take note.