AAPL holds a dominating market share in the technology industry. It is responsible for more than 20% of the PC market (including Mac and iPads), well above rival DELL (DELL) with its trailing share of approximately 7% in 2Q12. Not surprisingly, AAPL’s crown jewel, iPhone, with over 35 million sales worldwide, has enabled them to capture a global smart phone share of approximately 25% (18% in 2Q11), closing in on its major competitor Samsung (SSNLF) and its market share of 30.6%. Both Apple and Samsung grabbed sizable share from NOK, which currently stands as the third largest competitor responsible for 8% of smart phone consumers (down from 23% in 1Q11). Going forward, we foresee intense competition in the cellular segment, but expect the new launch of iPhone to surprise all estimates. In the PC industry, we expect the success story of iPad to continue augmenting the bottom line.
The dynamics of mobile communications has witnessed tremendous change over the years. The most recent transformation is from carrier-pushed choice to a consumer-preferred demand. AAPL capitalized on this shift by catering to consumer preferences. Consequently, iPhone accounted for 58% of consolidated revenues, which is at a record high since the inception of the company. The increase in sales is sustainable for several reasons. First, the company is continuously focusing on the type of cutting edge technologies that are expected to satiate the utility of end consumers. Second, its segment contribution is globally diversified with phenomenal increase from Asia mainly China, Hong Kong and Taiwan. This will mitigate any potential business risk that might emerge from saturation in North America and Western Europe. Third, major contribution of PC segment is owed to tablets where AAPL faces no serious threat. Therefore, despite the launch of Windows 8, iPads are likely to triumph the technology scene for the foreseeable future. Lastly, AAPL is likely to overcome the shortages in supplies of high resolution screens that will reduce the inventory turnaround time and consequently boost revenues going forward.
In FY11, AAPL showed improvement in margins owing to a strong growth of 65% in total revenues due to blowout demand from smart phone and PC tablet consumers. The pattern continued into 2Q12 with 88% unit growth in the cell phone segment, resulting in a gross margin of 47%. AAPL’s profitability was complemented by a modest increase in selling expenses enabling the company to post a net margin of 27% and, consequently, a high ROE of approximately 47%. We are confident that AAPL has robust earnings quality with strong overseas demand, augmented by contribution from the new iPad in the revenue mix. AAPL enjoys strong financial flexibility with an unlevered capital structure and a modest quick ratio of 1.5. In FY11, AAPL’s operating cash flows increased by 100% to $37B representing strong financial muscle to support research and development, which is very vital if the company is going to be able to sustain its competitiveness in such a dynamic industry.
A vital change in company’s policy is initiation of dividend distribution from the current year and a quarterly dividend of $2.65 per share. If the board approves, the payout is likely to put some strain on cash flows but, with the expected increase in sales through product and geographical diversification and minimal distortion in receivable quality, AAPL is well positioned to absorb the potential impact. The company has also addressed concern of dilution owing to the exercise of employee stock options and distribution of benefits through equity grants by approving a stock repurchase program. This repurchase plan has a funded value of $10B and is likely to neutralize any future dilution while adding economic value to company.
AAPL faces various risks that might originate from competitive pressures from Samsung, bottlenecks in production (as experienced recently) in its supply of high resolution screens, inventory risk due to its relatively limited number of suppliers and distortion in international operations that represents a major share in its revenue mix. However, owing to AAPL’s focus on service quality and innovation, we do not feel that consumer-side risk poses any major threat to local or international markets. The supply side could raise a red flag but given the company’s continued efforts on logistics and service providers, AAPL is not likely to experience material turbulence in their operations.
The valuation conventions for firms the size of AAPL should be carefully understood. AAPL is a growth stock with high price to book ratio of 5.5x and a PE ratio of 14.6 with a forward PE multiple around 12. Its declining PE ratio should not be surprising for the simple reason that with a company the size of AAPL, we cannot expect a PE ratio to be trailing very high, making it more expensive than GDP of some advanced countries. The Enterprise Value to EBITDA is at an impressive 10.05 that depicts strong valuation prospects for the firm. AAPL’s beta is close to 1 which explains its modest volatility, and that profile is unlikely to change. Going forward, based on the company’s strong fundamentals from its strengthening market position, sizable cash flows, low volatility and expected PE multiples, we value AAPL at $707. Billionaires Ken Griffin, David Einhorn, Jim Simons, and Steve Cohen are all current shareholders of the stock.