Over the past year, Apple (AAPL) has made a complete transformation in the way it is perceived by investors. Specifically, the stock has gone from a growth play to a value play, and has taken investors on quite a roller coaster ride as the transition has unfolded. Still, a lurking question on the minds of a lot of investors is whether or not Apple will reach the $700+ level that it saw so briefly last September, and if so, when could this happen?
Growth to value
For the sake of this discussion, I'm going to assume that Apple is no longer a growth company and will most likely never see the extreme growth rates of the last decade again. What does this mean for valuation of the stock? It means that the current valuation level is here to stay, give or take a little, and that a TTM P/E of 12.5 is probably close to what we can expect. If Apple releases a truly game-changing product, it could increase significantly, but I feel confident in saying that P/E multiples of 25 (like last September) are a thing of the past, regardless of how good Apple's future products are.
But wait, isn't 12.5 a little low, even for a value play? Yes, but I also believe that Apple warrants a considerable discount simply due to its size. Historically, when a company is in the top 10 largest in the market, it is much easier to underperform than overperform. In other words, it will be pretty tough for Apple to add significantly to its $156 billion in annual sales, but if the new product cycle flops, revenues could indeed plummet pretty fast. Anyways, the point is that as a value play, a P/E of around 12.5 is about right for a company like Apple.
Apple's product mix and sales data
About 90% of Apple's revenue comes from three sources: iPhones (50%), iPads (20%), and Macs (15%). The rest comes from iPods (3%) and other items like Apple TV (7%). The iPhone and iPad sales are growing, while sales of the rest are declining, at least relative to those two categories.
IPhones have been the company's fastest-growing product line in the past, and are still growing at a nice rate, having made up just 42% of the company's revenue in 2011. Based on the company's total revenue ($156.5 billion last year and $108.25 billion in 2011), this means that iPhone sales rose from $45.47 billion to $78.25 billion, a 72% increase from 2011 to 2012.
IPads have been growing tremendously in popularity since their introduction, and now are Apple's fastest growing product line after the iPad Mini was introduced last September. From 2011 to 2012, iPad sales rose 81%, and that does not include any iPad Mini sales, as Apple's fiscal year ends in September.
The percentage of Apple's revenue from computer sales declined from 20% to 15%, but the numbers actually increased from 17 million to 18 million (including desktops and laptops). The iPod holds about 80% of the music player market, but this is a rapidly declining segment, and no longer is a significant segment of Apple's business.
Goals and predictions …
As mentioned, Apple's fiscal year ends in September, and the company is expected to report revenue of about $169.4 billion, rising to $180.2 billion for fiscal year 2014, which runs through September of next year.
When predicting the revenue composition going forward, I make the following assumptions:
- The iPhone 5s and lower-cost iPhone are released in September and are well-received. The 5s will not be a game-changer, but the low-cost iPhone could result in tremendous sales growth
- The iPhone 6 is released in early to mid-2014
- The next iPads are released early in the fiscal year
- At least one completely new product (watch, TV, etc.) is released during the fiscal year
If all of that does happen as expected, and current trends in smartphones, tablets, and PCs continue, I project Apple's revenue mix for fiscal year 2014 to be as follows: iPhones 45%, iPads 32% (including the mini), Macs 10%, new products 8%, Apple TV and other 4%, and iPods 1%.
Based on the above numbers and a projected gross margin of 38%, Apple should earn about $42.00 per share, which according to the 12.5 P/E mentioned above gives a target price of $525 per share. Before you start calling me an Apple basher, note that this does not take into account several very realistic possibilities, such as a China Mobile (CHL) deal and more than one successful new product launch. I also don't consider this ho-hum case to be very likely. However, to get back to my original question of how Apple could hit $700 again, here are the scenarios that could positively impact Apple's share price:
- Due to a higher-than-expected retail price on the iPhone 5s and/or the 6, Apple is able to operate at a gross margin of 41% as opposed to 38%. This alone would raise earnings enough to give us a share price of $566.45 with a 12.5 P/E.
- The impact of China Mobile is so great that iPhone sales come in much better than expected. If 50 million of the low-cost iPhone (estimated to be between $300-400 at retail) are sold in China, that would add about $20 billion to iPhone sales. I feel that 50 million is a very attainable goal, as China Mobile has about 740 million subscribers, a great deal of which want the iPhone. Assuming these numbers are reachable, a China Mobile deal could raise Apple's total revenues by about 11%. This alone could increase earnings to $46.62 per share, which would give us a $582.75 share price at 12.5 times TTM earnings.
- A new product is announced that is an instant hit, such as an Apple TV (not the box, an actual TV). By a "hit", I would mean that a $1500 TV sells about 7 million units in its first year (same as the iPad's first year results). This could add $10.5 billion to Apple's revenues, which would boost our target to $555.60
- A combination of better than expected product releases creates a higher growth rate, which I think could push Apple's P/E up to about 15.
- The IDEAL case: All of the above happen over the next fiscal year. Apple's earnings could be around $53 per share if all of the above happens. At a P/E of 12.5, this would mean a $662.32 share price at the end of next fiscal year (September 2014). However, if all of this were to happen, it would most likely push the P/E up a little. If the P/E rose to 14 (still low, considering Apple's cash), we could easily see a share price of $741.00.
Now, I'm by no means an idealist, and I don't think that all of the positive catalysts above will happen just like that. My point is that Apple could very easily hit the $700 level once again. Most likely, I do think that the China Mobile deal will get done, and that it will have a huge impact on Apple's revenue, but maybe not quite as much as I discussed. Assuming that there is no game-changing new product line this year, the above scenarios can still produce a share price upward of $680 in a year from now. This is not to mention the ongoing share buybacks, which will also positively impact the value of Apple shares.
The bottom line is that Apple could easily become a $700+ stock once again, and I believe this will happen sooner rather than later.