Apple: $635 Price Target Feels Right

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 |  About: Apple Inc. (AAPL)
by: Bret Jensen

Summary

Apple was upgraded yesterday by a 5-Star rated analyst at Pacific Crest.

The company has catalysts that should help it break out to the upside in the second half of the year.

Given catalysts and the stock's valuation, Pacific Crest's $635 target seems very reachable over the next 12 months.

"Just be patient. Let the game come to you. Don't rush. Be quick, but don't hurry." - Earl Monroe

Pacific Crest upgraded the shares of Apple (NASDAQ:AAPL) from "Sector Perform" to "Outperform" on Tuesday. They also placed a $635 a share price target on the shares. Of course, analyst reports should always be taken with a grain of salt or two.

However, this report was issued by Andy Hargreaves who has the highest 5-Star rating from Tip Ranks for the accuracy of his previous calls compared with other analysts the service measures. One of the core reasons for Mr. Hargreaves' optimism is the upcoming version of the iconic iPhone franchise, the iPhone 6, which should have larger screens which customers and investors have been clamoring for.

Mr. Hargreaves believes the new version of the iPhone will add ~$4 a share in earnings in FY2015. This would have a big impact if prescient as the current consensus estimate for Apple's FY2015 EPS is just over $46 a share.

Although this $635 price target is ~$100 a share above Apple's current price, it is just under a 20% bump from the stock's current levels. This seems imminently achievable for reasons other than the iPhone 6, which should launch sometime later this year.

Looking to the East for growth:

Late last year Apple signed both NTT Docomo (NYSE:NTT) and China Mobile (NYSE:CHL) as new carriers. NTT Docomo's over 60mm high income subscribers got access to Apple's products late last year and the launch of the iPhone 5C/5S has already helped Apple increase its leading market share in the Land of the Rising Sun.

China Mobile's over 750mm subscribers just started to be able to acquire the new iPhones on January 17th when the carrier deal kicked in. This should bolster Apple's weak market share in the Middle Kingdom. I have seen estimates all over the map on this one but consensus feels like it calling for an incremental 10mm to 20mm devices in 2014 because of this agreement.

Obviously, both deals are going to make year over year comparisons much easier and should focus investors on accelerating growth Apple is experiencing in the East.

Innovation:

After much speculation, I expect Apple to launch iTV and/or a wearable technology product like the iWatch by the end of the year. I do not expect either to be material to earnings. However, the launch(s) should go a long way to erasing the perception that Apple can no longer innovate since Steve Jobs passed away. This is a core reason Apple trades at a significant discount to the overall market. Easing this concern should bolster the stock.

Sentiment Shift:

During last year's over 30% rally in the market, equities were led by the high-flying momentum sectors like Biotech and stocks like Tesla Motors (NASDAQ:TSLA). I believe this "froth" was a main driver of the huge rally as earnings only advanced ~5% year over year.

However, sentiment is a fickle beast. Any investor that needs to be reminded on how fast sentiment can shift in this market should look to the action in the small cap alternative energy space Tuesday. This sector was on fire to start the day with double digit percentage gains in early morning trading. This all went "poof" in the afternoon partly on a Citron report pegging the intrinsic value calculation on Plug Power (NASDAQ:PLUG) is just 50 cents a share. Plug Power, Ballard Power Systems (NASDAQ:BLDP) and FuelCell Energy (NASDAQ:FCEL) reversed their earlier gains and ended down 15% to 40% for the day. This is a huge swing by any measure.

When market sentiment does shift, funds should flow to stocks with lower valuations, stronger balance sheets, a decent dividend and lower betas. Apple fits the bill for a good place for migration flows when some of this froth comes out of the market.

Valuation:

Even as the stock has increased more than $140 a share from its lows in late June, the shares are still cheap. The market is currently trading for roughly 16x forward earnings and analysts expect the S&P 500 to post 4% revenue gains in FY2014. Apple sells for under 13x forward earnings and should increase sales in the 6% to 7% range in FY2014. The stock has a five year projected PEG of under 1 (.59) as well.

This does not account for the company's over $150B in net cash or marketable securities on the books or its 2.3% dividend yield. I expect Apple to add tens of billions of dollars to its buyback program and increase its dividend by the end of the year as well.

Although I still believe the shares will be stuck in a fairly narrow trading range for the first half of the year, I think the stock will bring out to the upside in the second half of the year for the reasons mentioned above. Pacific Crest's $635 a share price target seems very reachable over the next 12 months. ACCUMULATE.

Disclosure: I am 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.