Watch Apple's exposure to storefront real estate. When trouble becomes evident (storefront closing/downsizing), it is time to short. My thesis seeks to expose a fundamental weakness in Apple's liabilities, specifically, Apple's exposure to storefront retail. I believe Apple's growing storefront liabilities will eventually become a burden on cash generated from operating activities.
With the projected growth of e-commerce and the number of internet users in the next two years, along with Apple management's concerns over storefront overhead, I believe that Apple's commitment to retail storefronts poses a significant threat to its balance sheet in the next two years. Look for further signs of distress to assess a short sale opportunity.
Risk from Online Retail
Interactive Media in Retail Group (IMRG), a U.K. online retail trade organization, estimates that:
Global business-to-consumer e-commerce sales will pass the 1 trillion euro (1.25 trillion USD) mark by 2013, and the total number of internet users will increase to approximately 3.5 billion from around 2.2 billion at the end of 2011.
Apple Management's Concern Over Declining Operating Income Per Store is Warranted
At the end of its 2012 third quarter Apple had 372 stores open compared to 327 stores at the end of the third quarter of 2011. (Apple 2012 Q3 10-Q)
Apple reported operating income of $868M from its retail stores during the third quarter of 2012 compared to $802(NYSE:M) for the same period in 2011. The increase in store operating income for 2012 Q3 was due entirely to the increase in number of stores. The troubling fact for Apple management is that operating income per store actually declined by 5% in 2012 Q3 from what it was in Q3 of 2011: in
Q3(2011) OI ($802M)/327(stores)= $2,452,599 per store
Q3(2012) OI ($868M)/372(stores)= $ 2,333,333 per store
It is particularly worrisome that per store operating income fell when per store revenues actually increased year-over-year.
To boost store operating income Apple management is trying to drive sales through employee incentives while cutting store overhead. In August 2012, it was reported by various media outlets (Business Insider, MacAddict.com and bgr.com) that Apple was implementing massive layoffs, budget cuts and revenue incentives for retail store employees. Apple quickly reversed its layoff policy, but budget cuts and sales incentives remained.
IFOAppleStore.com, a news outlet focused on Apple storefront coverage, reported:
Despite a public acknowledgement by Apple that recent retail store staffing changes were "a mistake" and have been reversed, store employees still haven't received an official explanation of the changes, and signs persist of a continuing focus on revenues and profit instead of customer satisfaction.
Future profitability of Apple stores is clouded not only by overhead concerns but by the anticipated rise in consumer internet purchasing that will likely have an adverse effect on store revenues.
Apple's exposure to storefront real estate is significant:
Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of June 30, 2012, the Company's total future minimum lease payments under noncancelable operating leases were $4.1 billion, of which $3.0 billion related to leases for retail space. (Q3 10-Q)
Apple's huge investment in storefront real estate could be at risk if the competitiveness of its stores continues to erode as a consequence of Apple's inability to rationalize store overhead or the growth of online retail. In its most recent 10-Q Apple acknowledges that Apple storefront closings or underperformance would cause Apple to:
...incur substantial costs if it were to close multiple retail stores and such costs could adversely affect the Company's financial condition and operating results.
Use this information as a trigger for a short sale on the horizon, storefront closings would certainly increase liabilities and negatively affect cash from operating activities.