Apple Stock: This Is Not A Buying Opportunity
Summary
- Apple has dropped 5% this year even after beating Q1 earnings estimates in late January, yet the shares still do not present an attractive buying opportunity.
- Apple's estimates for the next two quarters, while set significantly above prior years results, should meet expectations on strength from 5G iPhone sales.
- Later in 2021, Apple results could come under significant pressure when 5G iPhone sales slow as consumer spending shifts away from electronics towards travel and other activities.
- I believe Apple's FY22 estimates are far too high and FY22 results will come in below FY21, which should pressure the share price.
My previous article on Apple (NASDAQ:AAPL) where I said Apple is a Sell generated an enormous amount of heat in the comment section from Apple bulls. Admittedly, the short-term timing wasn't good as Apple briefly ran above $140 on strength from a strong holiday quarter.
Fast forward to today and Apple is now underperforming the indexes by ~5% since that article. My sell call was based purely on valuation, and the 4 main concerns I had are still valid now
- Too much too fast: Apple shares have tripled since early 2019.
- iPad, Mac, Wearables, Home and Accessories had a great 2020, but I believe there was a significant demand pull forward from work at home and remote learning, and these categories could disappoint later this year.
- Share repurchases that have driven EPS gains in the past few years have much less of an impact at 28x earnings than they do at 12-16x earnings.
- Expectations for FY21 and FY22 and are very high.
I recommended Facebook (FB) last month because it had become too cheap relative to its future projected growth, and despite the constant negative headlines, the stock stopped going down. Apple seems to be doing the opposite; underperforming the market despite constant positive press because of a stretched valuation coupled with challenging future expectations.
Has Apple's recent dip made it a 'Buy' for long-term investors?
Let's start by putting the dip into perspective. At $123, Apple is down 15% from its 52 week high of $144.87 set in January. But Apple only closed above $140 for 3 days, January 25th-27th, before dropping to $136.89 on the 28th. Measured from there, it's down 10%. The dip really isn't that deep.
18 months ago on September 30th, 2019, Apple traded at $55.26. That was up from the trading in the low/mid $40's a few months beforehand.
What changed fundamentally that drove Apple, already one of the world's most valuable companies, this much higher? Did the market finally realize they were getting it wrong and undervaluing one the most followed companies on the planet?
I actually think the answer to this question is yes, but it only explains part of the increase.
Apple traded at a price/earnings significantly below the broader market until late 2019. I believe this was a clear mispricing. The revaluation towards the end of 2019, when it closed at $72.68, I thought was deserved and it was closer to fairly valued at that point.
However, I also believe 2020, especially the last half of it, was a generational opportunity for computer and other electronics sales to a world trapped at home due to COVID-19, at the same time that record low interest rates and easy money policies drove stock valuations higher.
Most analysts and investors are setting the blockbuster October-December 2020 quarter as a new baseline for Apple going forward, which I think will prove to be a mistake, while higher interest rates impact valuations of high multiple stocks.
What should investors expect from Apple's Q2 earnings?
Expectations are high for Apple's Q2 earnings. Because of COVID, Apple did not provide street guidance for the quarter, but analyst estimates currently stand at 98 cents of earnings on $76.8 billion in revenue.
This marks a significant acceleration from the $63-67 billion in revenue Apple guided before COVID hit, and the $58 billion they did in Q2-2019.
iPhone sales in China appear to be red hot which should provide a tailwind and PC sales are expected to remain strong for now. I think they meet or exceed estimates for Q2, with many of the same trends remaining in place for Q3 as well.
What happens after Q2/Q3 earnings?
I think trouble starts in the back half of the calendar year, especially in the important Q1-22 (October-December 2021) quarter.
By July, I expect the US to be nearly back to normal and for Europe and other COVID impacted countries to be well on their way. With this, consumer spending habits should shift from electronics towards activities - traveling, events, etc. How many new computers and iPads were purchased this year to support remote work and learning? (We purchased laptops for the more than half of our staff that didn't already have them and used desktop PC's in the office.)
At the same time, sales momentum from early adopters of 5G iPhones could begin to slow.
I think most would agree this is a reasonable scenario, but very little of this is in the current estimates. Apple's Q1 2021 (October-December 2020) could be the high water mark for a while and Q1-2022 could easily drop back closer to 2019 levels.
This is not a consensus view, but there's at least one analyst out there that agrees with me and has a $25 billion revenue decline estimated for next year.
The final quarter of 2020 was strong for all electronic sales, with PC shipments growing 10.7% and tablet shipments growing 19.5% (the tablet market was in slow decline for years until this point.) I think the chances of this strength repeating next holiday season are slim, but that's what is incorporated into current estimates.
Is Apple Overvalued?
I believe Apple is moderately overvalued currently. It's not a clear sell, and if I owned a significant amount of it with a low cost basis, I may continue to hold, fully expecting it to trade sideways for a few years as it grows into its valuation. Apple is a market leader with a wide moat, but it is still trading at a premium valuation with a mid single digits growth rate.
FY22 estimates, which effectively use the current year as a baseline, could be far too high, and the risk of Apple shares dropping towards the $90-100 range (which would still be higher than it was pre-COVID) is realistic if it proves to be the case.
Apple revenue declining year over year isn't without precedent. It declined between 2015 and 2016 ($234 billion to $216 billion) and again between 2018 and 2019 ($266 billion to $260 billion.)
There are several other negative catalysts that could impact Apple this year
- Tax Reform: Last year, Apple paid $10.8 billion in taxes on $74.6 billion in pretax income, for a tax rate of 14.4%. In the years before the TCJA reduced corporate tax rates, Apple paid a tax rate between 24-26%.
- Huawei Situation: Former President Trump effectively banned Huawei phones and pressured allies to do the same over national security concerns (CNET provides a good timeline for this.) This ban expires next month unless the current administration extends it. This ban certainly helped Apple is OUS territories, with Huawei sales down 41.1% in Q4-20.This is a complex situation, but my personal view is that China will not tolerate it forever, and either Huawei will be gradually permitted to sell again or China could retaliate against Apple.
Ultimately, if FY22 earnings decline from FY21 as I believe they will, Apple would then be a 30x+ multiple stock with stalled growth, and I think the market revalues it lower in that event.
Conclusion
I have tremendous respect for Apple and its management, but believe the valuation is still too stretched even after the small dip. Valuation matters. Nothing is "always" a buy.
I think too many Apple bulls have unrealistic expectations for the shares over the next few years, fueled by bull market nonsense like this gem from UBS claiming a skunkworks Apple Car project is worth $14/share or $230 billion - more than Volkswagen (OTCPK:VWAGY) and BMW (OTCPK:BMWYY) combined.
Because the stock went from $40 to $120 in the past two years does not mean it is going from $120 to $200 in the next 2 years. Apple traded at a 12x price/earnings in early 2019 and trades at a 28x forward price/earnings now.
I just don't like the risk/reward currently offered. I believe the most likely outcome is Apple trading sideways for several years, slowly growing into a more reasonable valuation. But I think the risk of FY22 disappointing investors and Apple stock dropping as a result is very real and far more likely than the market continuing to revalue Apple higher.
This article was written by
Analyst’s Disclosure: I/we 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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Comments (249)
Yes improving the current products is great and the prices can be raised but that it limiting the stock price and buyers budgets. Instead of finding fault with other companies and their business practices, he should look inward at what he should be doing. Furthermore, any interest in an electric vehicle is just to get the software in the car. He does not allow anyone to control anything or even have much of a say and is not working in his favor now that Apple is no longer a must own stock.
What did I miss on the M&A end? Small companies contribute to the existing only and Face ID is not what people seem to want. I am speaking of a market moving event. Can you imagine if he had bought NFLX years ago?