Bidness Etc. believes that despite losing its status as a growth stock, Apple's ability to pay dividends, an aggressive share buyback plan and cheap valuations make it a long term buy.
Apple Inc. (AAPL) surprised skeptics by selling a record nine million units of its new iPhones (5s and 5c) following their much-anticipated launch in September 2013. Soon after the launch, the company had raised its guidance for FY13, revising its expectations for full-year revenues to the high end of its previously-announced range of $34-37 billion. It had also said gross margins would expand to the upper limit of the 36-37% range in the last quarter.
However, despite these bullish guidance numbers, the company appeared to be in trouble when Strategy Analytics - a research and consultancy firm - released data, just before the latest earnings announcement, which indicated that Apple's 15.6% share in the smartphone market in the third quarter of fiscal year 2012 (3QFY12) had declined to 13.4% by 3QFY13.
But Apple had the perfect riposte when - in its earnings release for 4QFY13 - it beat its own, as well as consensus estimates by posting revenues and gross margins at the higher end of its target ranges.
Even though Apple's gross margins and net income were lower in the quarter over the previous year, investors are focusing on the fact that Apple sold 26% more iPhones, 33.8 million units in total, (the consensus had been on 33.4 million units).
However, the company would not comment on how well its much-touted "budget" phone - the iPhone 5c - did in the market, and instead pointed to the immense backlog for its premium-priced 5s. Considering that it has already cut production for the 5c, we can safely assume that the response has been lukewarm at best.
Tim Cook has reportedly said the 5c is a mid-tier brand, and that the 4s should be considered Apple's entry point into new markets. However, Bidness Etc believes the 5c is priced too high, even for a mid-tier brand.
During the quarter, Apple also sold 0.1 million more iPads, but 0.3 million less Macs over the same period of the earlier year.
While the demand for PCs has remained weak, International Data Corporation (IDC) says Macs are actually gaining market share, and Bidness Etc believes the drop witnessed in the quarter may be a stumble, rather than a sustained fall. With its new Mac range available at reduced prices, and more software and updates available free of charge, Bidness Etc believes that the MacBook in particular will be able to capture market share as both iPads and Macs gain traction in the education sector.
Apple had placed large bets on growth in China, currently its second-largest market. It launched both the iPhone 5c and iPhone 5s in the market, but was only able to record 5.6% higher revenues from the country over last year. Revenues from China totaled $5.73 billion for the quarter.
Revenues from Japan, meanwhile, surged 41% to $3.34 billion following a deal with NTT Docomo, Inc.
Dividends and Share Repurchases
So far in FY13, Apple has paid back $33.5 billion to shareholders through dividends and share buybacks. It has also declared a per share dividend of $3.05 for 4QFY13.
Apple reportedly plans to return another $100 billion to shareholders, with Carl Icahn pushing the company to initiate a $150 billion share buyback program.
Apple currently holds cash reserves of only $35.5 billion in the U.S. If Apple caves in to Icahn's pressuring tactics, it will need to borrow debt to pay future dividends. It's either that or pay repatriation tax on the $111 billion it holds in offshore cash reserves in case it brings that back to continue its buyback program.
Apple's guidance for the next quarter says gross margins will remain constant, but revenues are expected to clock in higher. The outlook for revenues reflects a year-over-year change of only 1-7% - significantly lower if compared to 1QFY13, when it registered 18% year-over-year growth in revenues; and 1QFY12, when revenues grew 73% over the preceding year. The guidance for gross margins reflects higher costs and lower prices of iPads and Macs, deferred revenues and foreign exchange headwinds in Japan.
Meanwhile, smartphone average selling prices (ASP) have declined worldwide from $427 in 1QFY12 to $335 in 2QFY13. Although Apple prices its products at a premium, the iPhone's average selling prices have also fallen 7% over last year, indicating that more consumers are buying older or entry-level models.
The company has factored this into its guidance for the quarter, estimating lower earnings growth compared to previous years. Pricing pressures are expected to further dent ASPs as Apple enters more emerging markets (it expects to have a presence in 100 countries by the end of this year).
Apple launched the iTunes Radio during the quarter. iTunes Radio is an Internet radio service which has already been tried by 20 million unique visitors. Once it has a stable user base, Apple can monetize traffic through mobile marketing, similar to what Pandora Media, Inc. (P) is doing with its Internet radio products.
Tim Cook has also alluded to new products in the pipeline, which will likely be introduced in the first half of 2014. These can include wearable technologies, which will be the next high-growth market once the smartphone market saturates. The highly-anticipated iWatch could be one such product in the pipeline for a fall 2014 release.
Growth and Valuation
Apple's revenues have grown nearly 45.5% every year for the past five years, while earnings have grown 62% every year over the same period. In contrast, analysts expect the company's revenues to rise only 7.3% every year over 2014-2017, and earnings to grow 5.6% per year over the same period.
The smartphone market is already maturing - especially in developed economies - and Apple's growth in emerging markets, where consumers prefer below $250 smartphones, might be lackluster due to price points it is offering. This, we believe, will contribute to Apple's slowdown in growth.
But Bidness Etc. is looking beyond Apple's historical growth rates. The stock has a dividend yield of 2.3%, and a shareholder yield of 6.7%, and is currently trading at a price-to-earnings (P/E) multiple (ex-cash) of 9.49x. Given such a low valuation, Bidness Etc believes that Apple's growth can be bought at a discount.