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In our last update we recommended investors to take advantage of the pre-iPad-mini launch market scenario and reduce the position in Apple (NASDAQ: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 (NASDAQ:DELL) and HP (NYSE: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 (NASDAQ:GOOG) has launched its Nexus 7 in partnership with Asus. Amazon (NASDAQ:AMZN) just upgraded its Kindle Fire series, and Microsoft (NASDAQ: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

Google

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 (NYSE: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)

Source: Apple Is Trading At 60-75% Premium To Its Sum Of Parts Valuation