In our last update we recommended investors to take advantage of the pre-iPad-mini launch market scenario and reduce the position in Apple (AAPL). The primary reason behind this advice was the increasing downside risk as iPhone 5 was getting bad publicity due to problems with its maps feature and its camera, among other problems. This article is aimed at removing the misconception that Apple is cheap because it is trading at a forward P/E of approximately 15x. However, we believe that this low P/E is due to very high sales estimates. To test this hypothesis, we conducted a sum of parts analysis for Apple's segments. Our findings show that Apple is trading at 60-75% premium to its sum of parts valuation. Therefore, we reiterate our underweight opinion.
$ millions other than EPS | Gross Margin | Gross Profit | EPS Contribution | EPS | ||||||||
2010 | 2011 | 2012E | 2010 | 2011 | 2012 | 2010 | 2011 | 2012 | 2010 | 2011 | 2012 | |
Desktop | 27% | 27% | 27% | 1,672 | 1,782 | 1,598 | 6% | 3% | 2% | 2.55 | 1.94 | 0.99 |
Notebook | 27% | 27% | 27% | 3,286 | 4,438 | 5,038 | 11% | 8% | 7% | 5.00 | 4.83 | 3.13 |
iPod | 27% | 27% | 27% | 2,224 | 1,770 | 1,663 | 8% | 3% | 2% | 3.38 | 1.93 | 1.03 |
iPhone | 53% | 55% | 57% | 15,994 | 33,508 | 43,879 | 54% | 62% | 63% | 24.3 | 36.5 | 27.2 |
iPad | 31% | 34% | 31% | 2,962 | 8,530 | 11,927 | 10% | 16% | 17% | 4.51 | 9.28 | 7.41 |
Peripherals & iTunes | 29% | 28% | 27% | 2,062 | 2,679 | 3,401 | 7% | 5% | 5% | 3.14 | 2.91 | 2.11 |
Software, Service & Other Revenue | 50% | 50% | 51% | 1,369 | 1,516 | 1,676 | 5% | 3% | 2% | 2.08 | 1.65 | 1.04 |
*Revenue Target= 156 bil 2012
Desktop and Notebook
The Desktop and Notebook segment is the oldest in the company. The industry has been showing a downward trend for the last few years. The primary reason behind this decline has been the increased growth in smartphone and tablet sales. The segments contributed $7.5 to the EPS in 2010, but this fell down to $6.76, a decline of approximately 10%. The growth in desktops slowed down significantly in 2011, but Notebook growth remains strong at 33%.
2007 | 2008 | 2009 | 2010 | 2011 | |
Desktop | 4,584 | 5,151 | 4,971 | 6,240 | 6,644 |
Growth | 12% | -3% | 26% | 6% | |
Notebook | 6,905 | 9,198 | 9,773 | 12,219 | 16,307 |
Growth | 33% | 6% | 25% | 33% |
The most relevant companies for this sum of parts evaluation are Dell (DELL) and HP (HPQ). The average P/E of both companies is, currently, 4.4x. Using 2012 estimate EPS of $4.12 and average P/E ratio of 4.4x, we get a PT of $18 for the Desktop and Notebook segment.
Competitors | P/E |
HP | 3.6x |
DELL | 5x |
Average | 4.4x |
iPad
Apple was the pioneer of the tablet industry, introducing the first tablet to the world. The iPad was a revolution in computing and many companies have followed in Apple's footsteps. The tablet market is, currently, highly saturated with products of almost all the major technology companies available in the market. Google (GOOG) has launched its Nexus 7 in partnership with Asus. Amazon (AMZN) just upgraded its Kindle Fire series, and Microsoft (MSFT) is all set to launch its Surface tablet by the end of the month. This has forced Apple to cut its iPad prices considerably, from $700 to $450, a 36% decline. The release of iPad-mini would affect both iPad and iPod sales. However, the extent of this effect can only be determined once the product is announced and its pricing strategy becomes clear. As the table shows, the growth in iPad has slowed down significantly between year 2011 and 2012, however, these are estimated figures. The iPad-mini launch can affect iPad segment revenues in 2013.
$ million | 2010 | 2011 | 2012E |
iPad | 9,566 | 24,903 | 38,790 |
160% | 56% |
We have listed some companies which are also in the business of manufacturing tablets, and can compete with the iPad. Using average PE of 10x, we can get a PT of $74 for the iPad segment of Apple's business.
Competitors | P/E |
HP | 3.6x |
DELL | 5x |
Lenovo | 17x |
Asustek | 14x |
Average | 10x |
Software, Online and iPod
The companies which are comparable in nature to these three are Microsoft and Google. The average PE of both companies is 12x. We can multiply the combined EPS of the three segments i.e. $4.1 with 12 x to get a PT of $48.1 for these segments combined.
Competitors | P/E |
15x | |
Microsoft | 9x |
Average | 12x |
iPhone
The most important segment of Apple remains the iPhone. The iPhone contributed more than 47% to total revenues in 2007 and analysts are expecting this contribution to go above 50% in 2012. The revenue growth in 2008 is not a comparable number as the first phone was launched in 2007, so the highest YoY growth during last five years was during 2011. The iPhone 5 has been praised by many pundits and many have criticized it as well. The purple images of the iPhone 5 camera, is being touted as another problem with the phone.
$ million | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
iPhone | 1,666 | 8,646 | 15,671 | 30,069 | 61,006 | 82,264 |
YoY Growth | 419% | 81% | 92% | 103% | 35% |
Competitors | P/E |
Samsung | 10x |
Nokia (NOK) | 9x |
RIM (RIMM) | 7x |
Average | 8.7x |
*RIM Forward P/E for 2014
Using an average P/E of 8.7x, we can calculate a PT of $237 for the iPhone segment.
Apple Segments | Value |
iPhone | $237 |
iPad | $74 |
Software, Online and iPod | $48 |
Desktop and Notebook | $18 |
Total | $377 |
Using this approach, the sum of parts valuation gives us a price target of $377, which is a 57% of the current price of $660.
Alternate Methodology
We can also create an average multiple based on the contribution to earnings of each segment. Using 2011 actual figures, we get the following calculations:
$ millions other than EPS | 2011 Weight | Competitors P/E | |
Desktop | 3% | 4.4 | 0.132 |
Notebook | 8% | 4.4 | 0.352 |
iPod | 3% | 12 | 0.36 |
iPhone | 62% | 8.7 | 5.394 |
iPad | 16% | 10 | 1.6 |
Peripherals & iTunes | 5% | 12 | 0.6 |
Software, Service & Other Revenue | 3% | 12 | 0.36 |
Average PE | 8.8x |
The following table gives us the price targets based on Yahoo estimates:
2012 EPS | PT | |
High Estimates | 46 | 405 |
Consensus Estimates | 44 | 387 |
Low Estimates | 43 | 378 |
As evident in the table above, using different estimates for 2012 EPS, the stock is trading at approximately 60%-70% premium to its fair value.
Using the same methodology for EPS estimates of 2013, we get the following PTs:
$ | 2013 | PT |
Low Estimates | 42.0 | 370 |
Consensus Estimates | 53.0 | 470 |
High Estimates | 63.0 | 560 |
Conclusion
We conducted a sum of parts analysis of Apple and found that the stock is trading at 60% to 70% in excess of its true valuation. The optimistic estimates for i-phone 5 have resulted in a 20% increase in EPS targets between 2012 and 2013. Analysts are expecting the iPhone 5 sales figure to be around 250 million, which almost exceeds the total to date sales figure of all other iPhone types. These estimates are extremely optimistic and can result in gross misconceptions about AAPL's stock value. Based on this analysis, we are giving an underweight recommendation for AAPL.
Risk Factors:
One can argue that AAPL deserves a premium valuation because of its balance sheet strength and popularity amongst consumers. However, even if we give AAPL a 50% premium to its competitors multiples, the stock still looks expensive. (8.8x times + 50% premium = 13.2x vs AAPL's multiple of 15x)
