Apple: Say Hello To Risk And Uncertainty

Oct. 2.12 | About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL)'s stakeholders and investors had almost forgotten the meanings of the words "risk" and "uncertainty." They relished certainty and security, as analysts continued to upgrade their estimates and Apple kept releasing newer versions of its products. However, the launch of the iPhone 5 was not just another product roll-out. We postulated again and again, how the smartphone market is different from other markets. Apple's newest product had to be innovative and, more importantly, flawless, because while Apple customers do pay for innovation; more than anything, they pay for reliability. The reviews are in and the company has failed on both innovation and reliability. To think that this is the end of Apple would be a mistake, but to not revise estimates would be equally wrong. There was a suspicion that the iPhone 5 would be lackluster, but no one even dreamed that it would have bugs and errors. The iPhone contributes more than 55% to Apple's total revenues, and uncertainty regarding sales of the iPhone greatly increases the risk for Apple investors. We believe Apple will still be given chances (iPad Mini) to prove that it can still innovate and that keeps us bullish on its stock. However, we believe that investors with Apple-heavy portfolios should reduce AAPL's weight, and take partial profits. The primary question for investors of growth companies is assessing the optimal time to take profits. We believe AAPL investors should use the pre-launch hype of the iPad Mini to take partial profits (cut your AAPL position into half), and keep the remaining for any potential post-launch upside.

Insider Transactions

There are a number of factors that cast doubts on the company's ability to achieve the expected growth. Apple insiders, like other insiders, hold information about the company, which is simply not available to other investors. Therefore, trades being made by an Apple insider are an important clue to other investors, with regards to their perception about the stock's pricing. The table below shows total insider sales from March onwards:

# of Shares Sold

Approx Px

Relationship

Levison

15,000

$570

Director

Forstall

64,151

$570

Officer

Dresler

65,000

$634

Director

Williams

4073

$595

Officer

Cook

30,439

$606

CEO

Campbell

10,000

$590

Director

Sewell

3,381

$688

Officer

Click to enlarge

Source: Yahoo Finance and Insider Monkey

The number of purchases in the last six months is negligible compared to the number of sales. According to Yahoo Finance data, in the last six months, 463,294 shares have been sold by insiders, whereas only 2,670 shares have been bought. During the same period, institutional investors have sold over $19 million AAPL shares; which give us a decline of approximately 3.8% in institutional ownership.

iPhone 5

Issues with the iPhone 5 have been extensively highlighted by the media over the last couple of weeks. The biggest shock to users came with the faulty maps application. To fully understand the iPhone 5 letdown, we must understand that the company under discussion is known for its attention to detail. Therefore, the question needs to be asked, was the map application not tested? Or was it tested and released anyways? These questions cast doubts on Apple's continued commitment to quality in the users' mind. The decision to create in-house software was a right one, but the lack of preparation for this important application is still questionable. Users have other complaints with the iPhone 5, aside from glitches in the map application. One of the biggest flaws is that the new iPhone is not scratch-proof. Many users have reported that after using the iPhone 5 for a few days, it filled up with scratches. Other hardware issues involve glitches with the screen and light leaking from the body. Users have also complained about the smaller connector port.

iPad Mini

The next big product launch expected by the end of this month is that of the iPad Mini. According to company disclosures, the iPad contributed approximately 26% to total sales last quarter. However, as opposed to the iPhone, the profit margins on the iPad are much lower. Apple disclosures reveal that the iPad's profit margins range from 23%-to-32%. One of the primary reasons behind the lower profit margins is the reduction in price due to high competition. The price of the iPad has been reduced from $700 in 2010 to $450. The iPad Mini will face direct competition from Samsung's (OTC:SSNLF) Galaxy and Amazon's (NASDAQ:AMZN) Kindle. We believe the biggest threat to iPad is from Microsoft (NASDAQ:MSFT)'s upcoming Surface tablet. The Surface has been designed with the point of view of giving users the option of a tablet, but the functionality of a PC. Loaded with Windows, which is the biggest OS for PC users in the world, Surface has the capability to give iPad a run for its money.

Valuations

Apple is still selling at cheap valuations compared to its competitors.

Name

Forward P/E

Apple

12.6x

Microsoft

9x

Amazon

109x

Google (NASDAQ:GOOG)

15x

Click to enlarge

Conclusion

The high estimate for AAPL's 2013 revenue is $63.5 billion, whereas, the lowest estimate is $42 billion. On an average estimate of $53.3 billion, this is a significant deviation of approximately $10 billion. We believe the new iPhone 5 has increased investors' risk. The company is giving the iPhone 5 one of the biggest roll-outs of all time. Within weeks of its launch, the phone is already available in 22 countries. This roll-out is already facing problems, for instance, the problems with the company's factories in China. The company missed initial targets of 10 million sales by September end. Whether it was due to stock out or less demand, it's a red flag for investors either way. The next big catalyst will be the iPad Mini launch, which investors should expect in October; although investors should be wary of the fact that an iPad contributes half to EPS of what an iPhone contributes (less margins). The stock has already fallen behind its pre-launch prices, so we believe investors should wait for the iPad Mini hype to build up and sell 50% AAPL holdings on pre-launch spikes, and keep the remaining for a potential post-launch upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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