Why Apple Is A Good Buy Now.
Apple (ticker: AAPL) shares took a big hit this spring after the U.S. and China ramped up their trade war by exchanging yet another round of tariff hikes. Apple assembles iPhones in China, and it also depends on China for device sales as well. That unique exposure leaves Apple vulnerable to both higher Chinese export tariffs and a downturn in Chinese consumer sentiment as the trade war drags on. However, despite the near-term headwinds, Bank of America analyst Wamsi Mohan recently listed 10 reasons to buy the dip in Apple stock following the company’s latest earnings report.
China Isn't As Bad As It Seems.
In Apple’s fiscal second quarter, greater China revenue was down 22% year-over-year, its second straight quarter of declines. On the surface, that seems like a troubling trend, but Mohan says it’s not unprecedented. In fact, from the second quarter of 2016 to the third quarter of 2017, Apple’s China revenue declined for six consecutive quarters before bouncing back. Apple’s revamped iPhone trade-in program and the value-added tax cut in China in April should help drive growth. Finally, Apple will likely take a more conservative approach to pricing when it launches its new family of iPhones in September.
iPhone Inventory Levels Have Improved.
In the first quarter, Bank of America estimates iPhone channel inventory fell by about 12 million units. That drop is the largest quarter-over-quarter decline in iPhone inventories in more than two years. Prior to the first quarter, inventories had climbed from 16.4 million units in the second quarter of 2018 to 22.4 million units in the fourth quarter of last year. Mohan estimates current inventory levels are at multi-year lows at around 10.4 million units. He says Apple finished the first quarter with inventory levels within its target range of between five and seven weeks of supply.
Margins Have Been Resilient.
One of the ways Apple has cleared so much inventory in early 2019 is by aggressively discounting iPhone prices. As a result, many investors were concerned about the negative impact those price cuts could have on margins. However, fiscal second-quarter gross margins were 37.6%, beating Mohan’s estimate of 37.2%. In addition, Apple’s high-growth services segment gross margins expanded by 1% to 63.8%. As high-margin services revenue grows to make up an even larger percentage of Apple’s overall sales, it will continue to boost the company’s overall margin profile.
The Trade-In Program Resonates With Customers.
Apple’s revamped iPhone trade-in program has been a big hit around the world, especially in China. Apple committed to simplifying the trade-in process, including the addition of new financing programs and a streamlined data transfer procedure. On Apple’s earnings call, management said the iPhone 6, 6 Plus, 6S, 6S Plus, 7 and 7 Plus models are the most popular trade-in models since the changes have been made. Mohan says most Apple users are not yet fully appreciating the trade-in value Apple is offering compared to third parties, and the financial benefit of the new program is still in its early stages.
Services Revenue Growth Is Solid.
High-margin services revenue growth decelerated to 16% last quarter. But Mohan says recent gaming approvals in China should help services growth ramp back up again in fiscal 2020. Apple said it now has more than 390 million paid services subscribers, up 120 million from a year ago. The company is targeting 500 million paid subscribers by the end of 2020. Apple just reported record App Store, Apple Music, cloud services and App Store search ad revenue and said Apple Pay transaction volume doubled from a year ago. Apple plans to expand Apple Pay to 10 additional countries this year.
The Installed User Base Is Still Growing.
The Apple bull thesis is clearly shifting from iPhone unit sales growth to monetization of its installed user base. Apple has an estimated 900 million global iPhone users and at least 1.4 billion total active devices. CEO Tim Cook did not provide updates to those numbers in the company’s most recent earnings call, but he did say that the installed base hit an all-time high in the fiscal second quarter. The bigger that user base grows, the more of an opportunity Apple has to monetize its users via new services offerings, such as its recently announced streaming video service.
Apple's Capital Return Program Is Unmatched.
Apple has one of the strongest balance sheets in the market, including more than $225 billion of cash on hand. Not surprisingly, the company just announced it is returning even more of that cash to shareholders. Apple approved a new $75 billion share buyback program and raised its dividend by 5% to 77 cents per quarter. Apple committed $27 billion to capital return in the first quarter and has previously said it plans to be “net cash neutral” over time. With that goal in mind, investors can expect Apple to increase its dividend and buybacks aggressively.
Other Device Sales Are Strong.
The slowdown in iPhone sales has captured plenty of headlines, but Mohan says other device sales are still trending in a positive direction for Apple. Apple’s iPad unit sales were up 10% in the fiscal second quarter, and iPad revenue was up 22% from a year ago. Mac unit sales were up 3% from a year ago, and Mohan says those numbers include a significant number of first-time buyers. Finally, Bank of America estimates Apple will sell 30,350 Apple Watch units in fiscal 2019, up nearly 50% from fiscal 2018 levels.
Apple Stock Remains Cheap.
Apple shares currently trade at a forward earnings multiple of just 15 and at just 11.8 times Mohan’s fiscal 2021 earnings estimates. Apple shares offer a better value than both the average technology sector stock (19.2 forward earnings multiple) and the overall S&P 500 (16.9 multiple). In addition, Mohan is projecting Apple’s earnings per share growth will reaccelerate to 13.1% in fiscal 2020 and 22.3% in fiscal 2021. As earnings and revenue growth rise, Mohan says Apple has an opportunity for earnings multiple expansion, potentially compounding the stock’s long-term upside.
Investor Sentiment Is Still Negative.
Finally, Mohan says investors are still relatively underweight Apple shares. According to UBS, active money managers are currently more underweight in Apple than any other stock. After a wave of trade war-related analyst downgrades in December and January, only half of the 40 analysts that cover Apple have “buy/outperform” ratings on the stock, according to CNN. By comparison, 46 out of the 47 analysts covering Amazon.com (AMZN) have “buy” ratings on the stock. These numbers suggest there is a major opportunity for analyst upgrades, and active fund managers have plenty of room in their portfolios to add Apple stock.
