Air T vs. Apple? Not Even Close

Intrinsic value in action

To better help us understand Intrinsic Value, let's look at two completely different companies. Both are making money and doing fairly well. One is well known and one is not. The first one is Apple Inc (AAPL). The second one, Air T (AIRT), is a small ($70 million in annual sales) company that focuses on regional delivery of airfreight and aircraft servicing equipment (such as deicing and catering lifts). For simplicity, we are not going to look at their balance sheets. Instead, we are only going to focus on earnings. To summarize their earnings picture:

• Apple's 2007 earnings increased by 71% ($4.04/share vs. $2.36/share in 2006); trailing 12-month earnings are $4.56/share (see conference call transcript)
• Air T's 2007 earnings increased by 22% ($.94/share vs. $.77/share in 2006); trailing 12 month earnings are $1.29/share

If we were to take these numbers and extrapolate them for the next 10 years, AAPL would have earnings of $567.57/share and AIRT would be earning $7.72/share. This is probably not realistic, especially for Apple--just consider how many computers and iPods have already been sold.

How much growth?

If instead we assume each company’s earnings grow by 20% annually for the next 10 years, you would get the following (discounting at 5%-- the current yield on high quality corporate bonds):

AAPL:

• Year 10 earnings of $28.11/share, present value is $17.26/share
• The discounted earnings for the next 10 years add up to $101.74/share

AIRT:

• Year 10 earnings of $9.42/share, present value is $5.78/share
• The discounted earnings for the next 10 years add up to $32.26/share

Keep in mind that we are not looking at any assets as part of intrinsic value, just earnings. While it would cost money to do so, the Apple brand clearly has a lot of value (goodwill) that could be monetized through licensing, royalties, etc.

Is this good or bad?

What does all this mean? As of yesterday (2/5/08), AAPL closed at $129.36/share and AIRT was at $10.83. Assuming these companies can grow earnings at 20% per year (10 years is a long time--life in prison sometimes lasts only 7 years), we can say the following:

• AAPL's current price, about $130, indicates it's going to grow earnings at about 25% for the next 10 years
• AIRT's current price, about $10, implies it's going to grow earnings at about 1% for the next 10 years

How fast are earnings going to grow? This is where stock research comes into play. One things is clear: 71% earnings growth is not sustainable for 10 years. Given the length of time, I would say that 20% is more likely. At this growth rate, earnings in 10 years would be a little over 6x higher than today. If AAPL kept the same margins, their sales in 10 years would make them almost as large as GE today. Why not 25%? At 25% earnings growth (assuming the same margins), AAPL would be larger than GE and approaching the size of today's Chevron --I'm having a little bit of trouble seeing this.

This leads me to believe that even 20% earnings growth may be optimistic. Still, let's leave the 20% earnings growth estimate for both companies. Here are some additional thoughts, starting with Air T Inc:

• If 20% earnings growth is sustainable, AIRT is currently priced at about 40% of its intrinsic value
• Even if earnings grow at only 3% per year, AIRT is still priced 10% below its intrinsic value
• AIRT has a great financial position (see my previous article) which, combined with the upside potential, provides a nice margin of safety
• About half of AIRT's business depends on Fed Ex (risk); with that being said, they have been working with Fed Ex since 1980 (stability)

Here are some thoughts on AAPL:

• Assuming a 20% earnings growth for 10 years, at $130, AAPL is still priced about 30% above its intrinsic value
• At $130, AAPL's earnings will have to grow at about 25% for the next 10 years to justify this price (i.e., for the Intrinsic Value to be about $130/share)
• AAPL also has a great financial position, although it needs lots of cash to constantly reinvent itself and its products (I have 4 Apple computers; each one was only sold for about a 6-7 month period before being replaced by a newer model)
• Ten years is a long time; about 10 years ago, rumors of AAPL's demise and even bankruptcy were widely circulating

Summary

While both companies are very successful in their own right, AAPL has lots of execution risk and most (if not all) of the upside is already built into its current price. As it's currently priced, Apple’s earnings will need to continue to grow at about 25% despite economic downturns, competitive pressures, and shrinking margins--not to mention the vagaries of consumer likes and dislikes. In contrast, AIRT is priced very attractively. Even at modest single-digit earnings growth, AIRT is below its intrinsic value. Even though the margin for error in aviation is virtually nil, its business is very straightforward. The company's strong financial position also provides a nice margin of safety.

Disclosure: The author is long Air T and Apple Inc.

Comments

[Jon T]

Predictable result when a number cruncher see nothing but numbers...

4m of a 30+% margin product sold in 200 days?

Mac sales running at 5 times the market rate?

Entering new markets like video rentals.

I could go on. Predictions of earnings in the light of these and other developments are impossible to make. Suffice to say they will be significantly higher than anything suggested in this article.

[ThinkFirst]

Another meaningless analysis based purely on numbers without considering the nature of the companies' businesses, the size of their markets, and their competitive positions.
What does AIRT do? This from Yahoo Finance: "Air T, Inc., through its subsidiaries, provides overnight air cargo services to the air express delivery industry. It also manufactures, sells, and services aviation ground support and other specialized equipment products, including aircraft deicers, scissor type lifts, military and civilian decontamination units, and other specialized types of equipment. The company offers its products to domestic and international passenger and cargo airlines, the United States Air Force, Navy, airports, and industrial customers. As of March 31, 2007, it operated 88 cargo aircrafts under dry-lease service contracts in the United States, the Caribbean, and South America; and owned 2 aircrafts. Air T was founded in 1980 and is headquartered in Maiden, North Carolina."
Does this company have any sustainable competitive advantage? Not that I can see. Are they ever going to have high margins? I don't think so. They are in a notoriously low margin business. Is there balance sheet strong? Not particularly. About 17% debt to equity ratio. Cash equal to amount of debt outstanding.
Not only that, AIRT's business is extremely cyclical. Couple of bad quarters and the company can easily go out of business. And, to assume that it can grow its revenues at 20% per year for the next 10 years?? This is what happens when neophytes start analyzing companies without any understanding of how business works.

[DanielAgramonte]

Supplemental Disclosure: The author is long 6 iPods and 4 Macs

[dithers]

Apple is a part of the fabric of our lives, the only OS alternative for consumers and business to Windows, controls online music sales and personal music players, has incredible design and innovation facility, is selling its computers at a phenomenal rate, ranks second in smartphones, - the list goes on and on.

The comparison is useless, mainly because the compnaies are so unalike, but also the valuation seems to assume that if Apple had to sell everything or had to give dividends or some nonsense.

Shares are pure speculation - the marhet is giving Apple a beating because it can.
There are no good reasons to undervalue Apple, indeed most analysts call for a $250 valuation this year.

[WAKEUP]

Apples to oranges fails, again.

[blah-blah]

Very well written Buffett analysis of both companies calculating their intrinsic value. It doesn't matter if it's Air T and Apple or ABC and XYZ, the numbers tell you whether it's over valued or undervalued.

Coolness and execution are all factored into the growth numbers they put out every quarter, that's all you need.

I would never buy a stock unless I feel it has a wide moat(tech moats rarely last more than 10 years) and I can get it at a significant margin of safety.

Apple at $90 may sound like a decent deal except that companies the size of Apple don't grow at the same rate in the next 10 years that they did for the last 10 years.

[Brandon]

Typical contrarian view of Apple by the troll under the bridge Blah123...

[blah-blah]

LOL! I wish the author had picked RIMM instead of AAPL - Same message, less fans.

[mkreisel]

Well, if you take a P/E=10 company and assumes 20% annual growth for the next 10 years, of course it will look undervalued at current price.

But what are the odds of that happening? Do you think the market is really that inefficient and stupid?

Thus your comparison is bogus. If you want to illustrate the virtue of low P/E stocks, Coach and Starbucks are far better candidates.

[blah-blah]

Ok, you win and Buffett was wrong.

I'm going to sell all my stocks and buy APPL and GOOG

[T Muller]

One thing author leaves out- Value of EPS for years 11 to infinity? The continuing value or residual value. That's important, it would add a few hundred dollars to AAPL's valuation assuming 20% growth for 10 years discounted @ 5%.

[DanielAgramonte]

Turley
You are exactly right. Taking EPS growth at 20% annually out to 20 years gives about $590/share. I used 10 years for a very practical reason: I suspect Steve Jobs will be sipping Mai Tais in Miami in less than 20 years (Bill Gates is already bowing out and Andy Grove is long gone, but John Chambers is still going strong at 58). In other words, 20 years is a long time and Apple may not even exist as we know it today. It was certainly a mess before Jobs came back--who knows what'll happen after he leaves. Then again, maybe in 20 years Warren Buffett will still be around (at 97) and Berkshire Hathaway's A shares could be trading at $1 million? Thanks for the comment.

[blah-blah]

20% growth for another 20 years? LOL!

[DanielAgramonte]

There's more analysis, this time more qualitative, on tap for Monday. Thanks for the comments and feedback. Your unique perspectives are appreciated.

[T Muller]

Daniel,

What you could is assume that sales don't grow after year 10, or grow at the rate of inflation. just need a continuing value. The constant growth model is used.

EPS(10) * g (inflation) / (Ke - g)

Or 28.11 /.05 and then discount to present.

I would probably use a higher discount rate than 5% for the first 10 years since the growth is uncertain and volatile, hence risky. Yet, for the continuing value or mature phase, I would use 5% there.

Just my opinion

[DanielAgramonte]

Turley,
Many companies use 8-10% as an internal hurdle rate--I was generous in discounting at 5% for years 1-10, as this is typically a risk-free rate. As such, discounting at 9.5% in the first 10 years, still assuming 20% earnings growth gives an Intrinsic Value of about $80/share (about 50% below current prices).

After that, I guess it's fair to grow earnings at 5% (who knows, we might have a depression at that point?). I really struggle after year 15--in practical terms, where was AAPL 15 years ago, and where will they be 15 years from now? Who knows? Regardless, growing revenue at 5% during years 10-15 gives us a valuation of about $117/share. While fraught with execution risk, this may be achievable. I haven't screened it lately, but I suspect VERY FEW companies have had 20% earnings growth for 10 years. Think about it--with compounding, etc., it would only take one flat year to mess things up.

That's where it starts to get inplausible. How many companies can keep from having a bad year or two during a 10 year stretch? As I recall, AAPL was losing money in 1999. Their phenomenal growth in 2005, 2006 and 2007 enabled them to overcome the drag at the beginning of the decade. Bottom line: while the constant growth model is good from a theoretical standpoint, and my mathematical brain wants to add something to cover earnings in perpetuity, I struggle to comprehend what might be going on beyond year 10, let alone year 15. The changes in the technology alone due to Moore's Law would be enough to boggle the mind after year 10. Lots of food for thought and even more risk and uncertainty. In short, plenty of moving parts for a company that, despite a good four year run, hasn't yet proven its ability to grow consistently for a decade. In fact, I can only think of a handful of companies that have shown an ability to grow a large enterprise for a decade, and many of them are already held by Berkshire Hathaway: GE, P&G, American Express and perhaps a couple of oil companies.

[T Muller]

Daniel,

I agree with what you are saying, but I'm not necessarily advocating projecting a growth rate after year 10. Just the value in perpetuity. So, let's just assume that AAPL continue to earn 28.11 every year after 10, hence zero growth.

So...
The PV of EPS for 1-10 is 101.74

Then the PV for 28.11 in years 11,12,13,14,......... 49,50,....
=28.11/.05=562.21
discount back from year 10-- 345.15

The total value of AAPL would be $446.89

I agree with your qualitative points. Spot on.