This article was originally published on Forbes on Jul 6, 2022,12:24pm EDTForbes on Jul 6, 2022,12:24pm EDT
Growth has been hit hard this year, particularly the technology sector, yet Apple has been an exception as Apple’s stock has positive 1-year returns of 2% and YTD the company has outperformed the Nasdaq and all other FAANG stocks.
Apple epitomizes what it means to be both a good value stock and a good tech stock with its strong margins, outsized cash flows, stable balance sheet, and a loyal base of customers supporting the brand. Apple has not only outperformed FAANG stocks over a one-year period but is also leading when we compare it over five years.
Apple’s return of 513% during the five-year period from January 01, 2017 to December 31, 2021 is also higher than tech giant Microsoft’s return of 441%.
Apple is Tech’s Best Value Stock
Apple has been very consistent with its margins and cash flows. The company’s operating margin of 30.82% and the net profit margin of 25.71% are excellent, while most tech companies are currently struggling with the bottom line. It also has an outstanding free cash flow margin of 26.37%. The company has also been shareholder-friendly since it consistently repurchases shares.
While comparing to other popular value stocks like Walmart, Apple is trading at a slightly higher forward P/E ratio of 23 compared to Walmart’s 19. However, the company’s net profit margin of 25.71% is very good compared to Walmart’s 1.45%. Similarly, Apple has an excellent free cash flow margin of 26.37% compared to Walmart's negative free cash flow margin of -5.15%.
This helps illustrate why Apple’s stock has held up well as investors are able to participate in the most cash efficient company of all time while also participating in the company’s future innovation cycle.
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Apple’s recent results
Apple’s revenue in the recent quarter grew by 9% year-over-year to $97.3 billion. The company’s revenues beat Wall Street analysts estimates by 3.5%.
iPhone sales increased by 5% to $50.6 billion and 8% to $122.2 billion for the H1 fiscal year 2022 ending September. iPhone sales face a tough comparable, as in the previous year, sales grew 66% in Q2 FY2021 and by 34% in 1H FY2021. According to data from Counterpoint Technology Market Research, the overall average selling price of the iPhone increased 14% YoY to $825 in 2021.
Luca Maestri, CFO, said in the earnings call, “Tim has mentioned a number of times the iPhone 13 family is having a really strong year. We — when we look at top-selling smartphones around the world, we've had pretty incredible results during the March quarter. The top six models in the United States are iPhones, the top four in Japan, the top five in Australia, five of the top six in urban China and so on and so forth. So, the iPhone 13 has been truly a global success.”
The strong demand for M1-powered Macs helped drive growth of 15% to $10.4 billion in the recent quarter despite supply constraints. The company also mentioned that the last 7 quarters were the company’s “best seven quarters ever for [the] Mac.”
The company released the new M1 Ultra in March. The M1 Ultra connects the die of two M1 Max chips to create a system on a chip (SoC) to offer 128GB of high-bandwidth and low-latency unified memory to offer peak performance from high-performance and high-efficiency cores in the M1 Ultra’s CPU. The GPU offers optimal graphics memory for GPU-intensive workloads and the Neural Engine runs up to 22 trillion operations per second.
Apple announced the M2-powered Mac at WWDC in June, offering a faster CPU, a more powerful GPU and also a faster Neural Engine. The upcoming release will also offer 50% more memory bandwidth and a larger cache with 25% more transistors on the second generation 5nm SoC design.
Services revenue grew by 17% to $19.8 billion. As the company’s installed base of active Apple devices increased, more revenue funnels to increase the company’s services business. The company has also witnessed increased customer engagement with 825 million paid subscriptions at the end of the March quarter, up 25% YoY.
Management is also looking to tap enterprise subscription revenue as the vast majority of its revenue comes from consumers. It has launched enterprise subscription services called Apple Business Essentials in the United States for small and medium-sized businesses, which is aimed to provide support to employee device management and iCloud Storage.
Luca Maestri, said in the earnings call, “Obviously, we sell Apple Care to enterprises already today. But we know enterprise in general as a market is a very interesting market for us and we're putting a lot of effort and focus on it and we believe we have really good opportunities to grow.”
The company has managed to maintain good margins. The gross margin was 43.75% compared to 42.51% in the same period last year. The company’s services business has a higher gross margin of 72.6%, while the product gross margin was 36.4%.
The operating profits were $29.98 billion with an operating profit margin of 30.82%, compared to $27.50 billion with an operating profit margin of 30.70%. Net income was $25 billion or $1.52 per share compared to $23.6 billion or $1.40 per share. The net profit margin was 25.7% compared to 26.4% in the same period last year.
The company has good operating cash flows. In the recent quarter, it reported 28.2 billion of operating cash flows. The company has a stable balance sheet with cash and marketable securities of $193 billion and debt of $120 billion, with a net cash position that comes to $73 billion. The company returned $27 billion to shareholders through dividends of $3.6 billion and share repurchases of $22.9 billion.
The company’s share buyback strategy was appreciated by one of the analysts in the earnings call. To a question on why the company is not looking for acquisitions instead of only buying back the stock. Tim Cook replied, “We're always looking and we continue to look. But we would only acquire something that were strategic. We acquire a lot of smaller companies today and we'll continue to do that for IP and for great talent. And — but we don't discount doing something larger either if the opportunity presents itself. And so — but I don't want to go through my list with you on the phone, but we're always looking.”
Looking forward
iPhone sales account for the majority of its revenues (accounted for 52% of the total sales in the recent quarter), which helped the company reach record FY 2021 revenues of $365.82 billion, a YoY growth of 33%.
Wall Street analysts expect revenue to grow by only 7.7% this year and 5.4% in the next year. For next quarter, analysts are expecting revenue to grow by 1.53%. Management had mentioned in the earnings call that supply chain issues, and silicon shortages will negatively impact the company’s revenues in the June quarter.
“We believe our year-over-year revenue performance during the June quarter will be impacted by a number of factors. Supply constraints caused by COVID-related disruptions and industry-wide silicon shortages are impacting our ability to meet customer demand for our products. We expect these constraints to be in the range of $4 billion to $8 billion which is substantially larger than what we experienced during the March quarter.”
However, from the recent data, some analysts are pointing to wins in China. UBS analyst David Vogt said, “During May, overall smartphone shipments in China decreased ~9% YoY despite an easy comp last year (May 2021 down ~31% YoY). However, on a month-to-month basis, shipments were up ~16% as data suggests Covid lockdowns and supply chain shortages on the margin are abating, consistent with our recent checks. More importantly, we estimate iPhone shipments increased ~13% YoY and ~155% month-over-month as Apple took material share, consistent with our checks.”
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How does it compare to FAANG companies?
The company’s operating margin of 30.82% is the highest among the FAANG companies. Meta’s operating margin of 30.54% comes second and Amazon has the lowest operating margin of 3.15%.
Meta Platforms has the highest net profit margin of 26.75% among the FAANG stocks. It is followed by Apple with a net profit margin of 25.71%.
Apple stock is currently trading at a forward P/E ratio of 23. The stock is reasonably valued when compared to other FAANG stocks. Meta Platforms is the cheapest among the FAANG stocks. However, the company has a history of problems like privacy issues and the company’s loss of advertisement revenues due to Apple’s IDFA changes. You can read our analysis here on Facebook as to why the company continues to face headwinds to its core business model.
Apple has a high free cash flow margin of 26.37% and is ranked second behind Meta Platform’s free cash flow margin of 30.94% and significantly higher than the Amazon’s negative free cash flow margin of -15.24%.
Risks to consider:
Apple’s revenue growth has been decelerating. FY 2021 was an exception as revenue grew by 33%. However, growth in the FY 2020 was 5.5% and in the FY 2019, revenue fell by 2%. According to the Wall Street analysts revenue is expected to grow 7.7% in this fiscal year ending September 2022.
Morgan Stanley analyst Katy Huberty lowered the company’s price target to $185 from $195 and kept an Overweight rating on the shares. The analyst said, “High-end consumer spending intentions are beginning to deteriorate, as the stock market is down 22% year-to-date, consumer confidence is at a 10-year low, and inflation is at 40 year highs.” She further added, “The risks of a pullback at even the high-end consumer space are rising, and that a majority of survey respondents expect to reduce spending in the next six months due to inflationary pressures.”
In addition to the macro risks mentioned above, it’s worth noting that Apple’s revenue growth deceleration in 2019 also occurred when the US Consumer Price Index was at 1.71% in September 2019 compared to the current 8.6% in May 2022. It’s worth noting that Apple’s revenue deceleration occurred when inflation was low. We covered the deceleration in 2019 as we believe it was due to broad-level saturation across the mobile industry with Covid creating an anomaly in terms of demand for personal electronics.
Conclusion:
We recently covered Apple in a webinar where we discussed the two leading FAANGs in terms of sizable catalysts on the horizon that will help them to remain on the Top 5 for World’s Most Valuable Companies. Apple was not one of the two FAANGs discussed as the company does not a massive catalyst on the horizon like two of its peers —- yet this is entirely irrelevant to value investors. Thus, the stock has outperformed in an environment when value stocks are favored.
Apple has a great lineup of products with a loyal customer base supporting its valuable brand IP. The company’s margins and strong operating cash flows have positioned the company to overcome the global uncertainty. Notably, the company’s revenue growth is slowing down, and as growth investors, the stock does not fit our investment profile despite its considerable strength as a value stock.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.