Back in September 14, 2012, we argued that Apple was
not such an attractive investment because its high stock price was the product
of very high gross margins. We doubted
that the company could keep its expansion pace by targeting emerging markets
which, while offering much promise, could likely not afford the same high
device prices practiced in the US and other mature economies. We estimated that, should these margins shrink,
the implied stock valuation would look rather high: 18.2 times net profits,
after subtracting the cash and investments from the market capitalization.
Where are we now?
Since then, most analysts and commentators have discovered the
importance of gross margins and Apple has released quarterly financials showing
its margins are under pressure. The growth
pace of unit sales has decreased and instead of blowing estimates, the company
is missing some or just beating others.
In short, Apple appears to have become a “normal” company, no longer
managed by its mythical founder, albeit one with annual sales on the order of
$180 billion, and cash and liquid investments of $137 billion.
The question is this: while it looked (to me at
least) richly value at $692 per share, what to make of its current price of $450?
If I take key analysts’ estimates for 2013 as a
starting base but lower the gross margin from 40% to 30%, I get a net profit of
$30/share and a free cash flow (cash flow after capex) of $36/share. At the current share price, Apple sells at a
p/e of 15 times 2013 net profits.
However, given the huge liquidity held by the company, it seems more
meaningful to calculate a p/e multiple after subtracting cash and near cash from
the company market value (we must also adjust downward the 2013 year-end liquidity
for the lower projected income resulting from the lower gross margin). This adjusted p/e comes to 9.7 times.
We ran another parallel calculation based on free cash
flow. We got a multiple of 12.6 times
market value and 8.1 times market value adjusted for net cash.
From market darling, Apple has become market black
sheep. As it was overly own, it is
reasonable to expect continued selling until investors feel, if not comfortable,
at least ‘safe”. In other words, the
pendulum of emotions which swung wide one way is likely to swing wide the
other. We could get to $400; some now
predict a price in the $300 range. Who
knows.
It is true that keeping up innovating and dazzling
customers is very difficult. One can
think of the fashion industry which must come up with four new looks every
year. Except that Apple has over 500
million customers, offers both hardware and software products, most of which
can be described as aspirational, and has all the cash it needs to carry out
almost any strategy. Finally, one common feature of great companies is great culture. In this regard, it seems to me that Apple started well but recently stumbled, taking shareholders for granted and displaying some grating hubris.
Pulling it all together, my view is that, even after reducing expected gross margins to more sustainable levels, a free cash flow yield of 12.3%
(the inverse of 8.1) is an interesting investment proposition, even if the stock price falls further. I bought some shares today.
