Apple: Headwinds Mount Due To Pulled Forward Demand

Summary

• Apple faces a tough road in the next year after peak iPhone sales in FY21.
• The key Morgan Stanley analyst cut Services revenue growth to a meager 11% in FQ2 as Apple faces tough comps.
• The stock has the lowest forecasted revenue growth rate among tech giants in the next fiscal year.
• The stock is not justified at the current forward P/E ratio of 25x.
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As Apple (NASDAQ:AAPL) struggles to remain above $130, the market will have to counter the peak iPhone sales with some headwinds facing fast growing Services revenues. The stock remains priced for perfection while the tech giant faces tough comps over the next couple of years. My investment thesis continues to remain Neutral on the stock.

iPhone Peak

After a massive March quarter, the stock hasn't rallied at all. Apple reported that revenues surged 54% as the sale of 5G iPhone 12s boosted sales to $89.6 billion. In fact, iPhone sales in the quarter at $47.9 billion beat analyst estimates by over $7.1 billion.

The tech giant is forecast to sell up to 240 to 250 million units in FY21, topping the 231 million record going all the way back to FY15. Apple generates more sales from iPhones now due to higher ASPs, but the company can only grow this portion of the business so much with a larger portion of the new phones already selling for prices in excess of $1,000.

For this reason, quarterly sales are expected to trend toward flatline after the 5G iPhone year passes. Currently, analysts have FY22 March quarterly sales declining 2% as iPhone sales won't top the peak levels of FY21.

Source: Seeking Alpha earnings estimates

The iPhone sales are forecast to be significantly weak to offset a Services business growing in the range of 20% growth. At this growth rate, Apple would generate $3.4 billion in additional Services sales next FQ2. Of course, the company faces some tough comps for the Mac and iPad next year as well.

Services Headwinds

The ultra bull analyst on Apple recently cut the price target despite strong services demand. Morgan Stanley's Katy Huberty cut the price target for the stock to $156 back in early April before raising the target to $161 after the tech giant reported blowout Q1 earnings.

The analyst targeted FY21 Services revenues growing 22%, 4 percentage points above average analyst estimates. The analyst saw App Store revenue growth slowing closer to 20% growth after reaching 30% levels during the pandemic, but the updated Tower Sensor numbers has Katy Huberty slashing June quarter App Store growth.

The analyst cut Services growth to 11% based on only 16% App Store revenue growth in April, 7% in May, and 10% in June. The reduced growth rates for Services will reinforce the tough comps the company faces going forward.

The biggest risk to the story here is that Apple might be forced to cut App Store fees below the current 30% rate for the first year. The company might actually see a more sustainable business model with a lower rate but investors could face a year where App Store revenues don't grow substantially above the $43.9 billion level in 2020.

The company already has moved to cut fees to small businesses, but work by Morgan Stanley already has shown only the top 1,500 developers matter to the revenue base. Investors have to worry about cuts to the fees from the top developers as follows based on percentage of App Store commissions:

• Top 10 = 24%
• Top 100 = 59%
• Top 1,000 = 89%

On Jan. 1, Apple implemented a cut to the fees for software developers earning less than $1 million in net fees to just 15% for all sales. As shown above, these developers don't impact the revenue base of the tech giant and is why Epic Games remains in a legal case against Apple.

The biggest risk to the stock and the company would be a rerating of the existing App Store commission base at the same time that product sales face tough comps and App Store revenues are falling below the 10% growth level. Katy Huberty places a $161 target on the stock based on 31x P/E multiple.

The multiple appears far too rich for a company running into weak growth metrics, even in the Services category. The stock trades in a similar range of the other tech giants of Facebook (FB), Alphabet (GOOG, GOOGL), and Microsoft (MSFT).

Data by YCharts

The major problem is that Apple doesn't have the same projected growth rates of the other tech giants. Analysts have the following estimates for revenue growth next fiscal year for each tech giant with Apple as the only company not targeted with double-digit growth rates:

• Apple - 4.2%
• Facebook - 18.3%
• Alphabet - 15.9%
• Microsoft - 11.5%

Takeaway

The key investor takeaway is that Apple is now facing headwinds in the Services sector while in a major trial regarding App Store commission rates. The tech giant already faces a challenged growth environment in the next year ahead due to pulled forward revenues and the 5G iPhone boost.

The stock has no justification for trading around $130, much less at a 31x P/E multiple. Investors should continue to only look for weakness to buy Apple.

Analyst’s Disclosure: I am/we are long AAPL. 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.