Apple At $800: Flight Delay Or Cancellation?

| About: Apple Inc. (AAPL)

On August 15, 2011 we wrote an article titled: "Who will take a bite out of Apple? Anyone?", where we identified 9 hurdles that a technology company would have to overcome in order to take a bite out of Apple (NASDAQ:AAPL). At such time, on a dividend and split adjusted basis, Apple shares were trading at $372.89. We concluded that only a radical shift in technology (in case Apple is unable to capitalize on) can possibly take a bite out of Apple, or possibly Apple can take a bite out of itself due to severe mismanagement, both of which we concluded were highly unlikely. We followed with a series of additional Apple articles, calling for Apple to reach $400, $500, $600, $700 and $800. Apple shares were flying high, reaching all our predictions with the exception of the $800 destination. Is this a severe flight delay, or is it a flight cancellation?


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Apple Stock from 1/1/2011 to 10/4/2013 - Source: Yahoo Finance

We would conclude it is a flight cancellation only if the above two stated reasons have come to fruition. As far as competition from Samsung and others, we still believe they lack the ability to overcome some of the nine hurdles we described in 2011. Specifically, we do believe that Samsung still lags behind Apple in innovation, creativity, design and integration. Most importantly, on the integration and innovation side, Apple is distancing itself from the competition by moving its entire product line to the 64 bit A7 processor in record time, as outlined by an excellent article by Ed McKernan, "The coming market impact of Apple's 64-bit A7."

As far as Apple being subjected to a radical shift in technology introduced by others, that certainly hasn't occurred during the past two years. As a matter of a fact, one can go further and argue that it is Apple that is actually leading a radical shift in technology through its migration to the 64 bit A7 processor. In addition, Apple is still leading in the introduction of non-radical technological improvements such as fingerprint recognition enabled iPhone, voice recognition capabilities, etc. ...

Has Apple taken a bite out of itself? Well, maybe it has taken a nibble ... There is no question that the passing away of Steve Jobs was a loss for Apple and the entire technology industry. However such unfortunate event is beyond anyone's control. As we stated in our 2011 article:

There is no question that Steve Jobs has a lot to do with Apple's success. However, it is highly unlikely he did it all on his own. As a company matures, as long as it is true to its vision, mission and philosophy, and as long it continues to be able to attract the brightest minds, it will flourish. Apple is well managed, as is evident by Steve Jobs extended health leaves.

Apple nibbled on itself at the introduction of its iPhone 5 in 2012. Its margins and sale volumes were hurt due to shortages and limitations of large scale manufacturing capabilities by Apple suppliers for some components such as in-cell touch screens and 4G LTE wireless chips. Apple also nibbled on itself through the introduction of Apple Maps where the software was released while it still contained flaws in providing driving direction. Nevertheless, both such nibbles were somewhat inevitable.

In a sense, we sometimes need to nibble, not necessarily because we are about to take a bigger bite, but because we are tasting, in order to improve the recipe ... The introduction of a new technology, necessary in order to stay at the forefront of innovation and creativity, can often meet initial manufacturing production line challenges which are ultimately overcome. Similarly, mapping software is quite complicated, and sometimes placing such software in use is the best way to discover its shortcomings in order to improve it and strengthen it.

So if Apple has not taken a bite out of itself, there has been no new disruptive technology, and competition is still unable to overcome the 9 hurdles, then what happened to the Apple flight? It is delayed. However, it is not delayed because the plane is not fully serviced, refueled and ready to take off. It is delayed because the passengers are taking their time in boarding the plane.

The flight analogy gives good insight into human psychology. When we rush to an airport to catch a flight, we immediately check the electronic board to confirm the status, then we check in and get to the gate in time with almost total confidence that the flight will be on time. However, once we learn there is a delay, we act almost in total disbelief and disgust. Once boarding starts, as long as other passengers have not boarded yet, we are tempted to stay seated, as it is more comfortable to sit in the lounge than to sit in the cramped plane seat. Once passengers start boarding, and when we feel we may miss the plane if we don't move, reality hits us that the flight will take off after all, and we then rush in a hurry to get on board.

Now is boarding time for Apple shares' delayed flight. Apple shares are currently trading at a price of $483.03 as of the close of October 4, 2013. With analysts' estimates of $39.33 for the year ending September 2013 and $42.99 for the year ending September 2014, Apple shares have a price/earning ratio of 12.28 and 11.24 respectively.

Apple's market capitalization is currently $438.83 billion. Meanwhile, it is estimated that Apple currently holds 10% of all corporate cash. When we exclude Apple's $147 billion in cash and long term investments, with an adjusted market capitalization of about $292.2 billion, Apple's adjusted price/earning ratios would be 8.17 for the year ending September 2013 and 7.48 for the year ending September 2014.

During the next several weeks, there is good likelihood that analysts' average earning estimates for Apple will be revised higher for the year ending September 2014. Analysts had expected Apple to sell about 6 million iPhones during the launching weekend in September for the iPhone 5c and iPhone 5s, while Apple exceeded such expectations by selling over 9 million iPhones. Apple has benefited from signing up Japan's largest mobile carrier NTT DoCoMo, in addition to the early launch in China.

Some would counter such outlook by claiming that Apple will lose the luster of some of its products such as the iPhone. I believe we are still many years away from such potential materializing. As an example, I have been opposed to buying my children a $600 to $700 phone based on principle. Yet, my 15-year old daughter this summer accepted an internship that only paid her $200 per month. In addition, she launched a baking business, hence working a total of no less than 6 hours per day including weekends. By the end of the summer, she had saved about $700, which she then spent it all on buying an iPhone. I was not happy and confiscated the phone as I found it to be too extravagant for a 15-year old to have. Naturally, I caved in and let her have the phone within a few hours; as she explained, the main reason she had worked hundreds of hours was to buy the iPhone. I asked her how she would feel if it was lost or stolen the next day. She replied that she would work again hundreds of hours to buy another one ...

Although some analysts may be hesitant to upgrade their earnings forecasts as they may deem such weekend launch success as a seasonal factor, it does confirm to us that production bottlenecks that haunted Apple last year are less likely to repeat. This would lead to improved margins, as Apple has already provided an upgraded guidance by stating its margins would come in at the top end of its forecast of 36 to 37 percent. Hence, average estimates for earnings of $13.75 per share for the quarter ending December 2013 could prove to be conservative.

Given Apple's incredible cash generating capacity, its dividend yield of about 2.5%, its existing dividend and share buyback program of $100 billion (while being lobbied by investors to increase its share buyback as per Icahn's push for a $150 billion share buyback program), the encouraging prospects for iPhone 5c and 5S, the attractively low adjusted price/earning ratio of 7.48 for the year ending September 2014 (upon exclusion of its cash and long term investments), its migration to an across the board advanced 64 bit A7 chip technology, we believe Apple shares can record substantial gains during the months ahead.

Investors who share our outlook can either buy Apple shares at current levels, or if interested in limiting downside risk, can possibly purchase calls expiring January 2015 with a strike of $530 for about $48. Break-even level would be about $578. As long as Apple Flight 800 reaches its destination (or even a fraction of its destination) by January 2015, investors would generate profits. Otherwise, investors could lose the premium spent on the options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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