How $10 Billion Gets Apple's Stock To $750

Apr.29.14 | About: Apple Inc. (AAPL)

Summary

Assuming that Apple can achieve 10% to 15% market share in wearable tech, this can immediately become a $10 billion revenue stream.

These products could add an immediate boost to Apple's revenue and (on their own) become multi-billion dollar businesses for Apple.

From my vantage point, there is still potentially 30% upside, which places the stock right around $750, $27 shy of Apple's highest price target of $777.

For almost two years, every market participant (I won't say expert) has had an opinion of what was wrong with Apple (NASDAQ:AAPL). The company was perceived "too arrogant" and pandered only to "the elite." Some claimed when Steve Jobs died, Apple's innovative quality was buried with him. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Samsung (OTC:SSNLF) had done too much damage from which Apple couldn't recover. For others, current CEO Tim Cook was the problem. He had to go, they insisted.

According to former Wall Street Journal writer Yukari Iwatani Kane, Tim Cook was nothing more than a "stage manager." A Forbes writer recently called the embattled CEO a "train operator." Three weeks ago, the poor guy offered "four reasons to avoid Apple's stock." Since then, Apple's stock has soared 17%. But how could he have known. He did nothing but drink the Kool-Aid being poured by everyone who believed they could run this company better than Tim Cook. Apple was everyone's punching bag. Until last week happened.

All of a sudden, following Apple's blowout quarter, everyone is proclaiming how they've been right about Apple. The company's future is now "favorable." But consider, even when things appeared gloomy, Apple had never missed its own estimates. In fact, for -now - four consecutive quarters, Tim Cook has met or beaten the midpoint of his guidance. But even with Apple's recent surge, the stock remains considerably undervalued to both the company's near term and long-term potential. Before I explain why, allow me to go over the numbers for a moment.

First and foremost, we know that Apple beat on both revenue and profits. With second-quarter revenue advancing 5% year over year to $45.6 billion, this was by-far, Apple's best non-holiday quarter ever, especially considering that net income climbed 7%. Revenue was driven primarily by strong iPhone sales, which soared 17% for the period.

But while management was diplomatic in saying that the iPhone "sold well across geographies," I couldn't help to notice how analysts under-projected the impact of China Mobile (NYSE:CHL), which was clearly the difference maker this quarter. Apple's revenues in China grew an impressive 13% year-over-year. Even more impressive was that despite the presumed "cost-conscious" Chinese consumer, the stronger-than-expected iPhone demand still achieved gross margins of 39.3%. This is a 180-basis point increase.

Disappointingly, analysts have chosen to not highlight how well Apple did in other parts of the world. Consider, in parts like Brazil, Poland, Turkey and Indonesia, Apple posted double-digit year-over-year revenue growth. And these were the areas feared would be impacted by weak average selling prices. Not to mention, high-end device saturation. But the $40 sequential decline in ASPs had little impact on Apple's gross margins. Management figured out ways to adjust the mix to achieve its profitability goals.

More than anything, the strong margins is what has spurred the run-up in Apple's stock. Apple is once-again demonstrating its heavyweight status. That, combined with the company's aggressive share buybacks helped push diluted earnings per share to jump 15% from the year-ago quarter, blowing past Wall Street expectations. But as noted, even with the recent run-up in share price, this strength is only the tip of the iceberg.

Beyond the company increasing the size of its capital return program by $30 billion, Apple has promised it will enter a new product category this year. The rumors center around the iWatch. There is also the mention of an iTV. I believe these products could add an immediate boost to Apple's revenue and (on their own) become multi-billion dollar businesses for Apple. But it's not only about an iWatch or an iTV, it's about their potential effect to Apple's existing ecosystem and their ability to drive iPhone/iPad sales higher.

As it stands, the wearable tech industry (watches) has gross margins ranging from 50% to 60%, according to Bloomberg. This fits right into Apple's core. And assuming that Apple can achieve 10% to 15% market share, which is conservative, this can immediately become a $10 billion revenue stream. Recall, this is what the iPod did when consumers didn't even know they needed it.

When you combine this with the $150 billion revenue by the TV industry in 2013, Apple stands to make more than $5 billion in potential gross profit. And that doesn't even factor the upselling capability both devices present to iPhones and iPads. The growth opportunities are endless. But long-term investors already knew this. The rest of the market is just now realizing it.

With the stock trading right around $595, Apple is a sure-bet to reach $600. But the more pressing question is, how far long can these shares run? From my vantage point, there is still potentially 30% upside, which places the stock right around $750, $27 shy of Apple's highest price target of $777. This means 7:1 split-adjusted price target of $107.

Disclosure: I am long AAPL.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.

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