Stock of the week - Apple (13.06.2024)

• Apple held developers' conference on Monday
• Market reaction was mixed at first but stock rallied later on
• Stock made biggest single-day jump since November 2022
• Apple briefly overtook Microsoft in terms of market capitalization
• New AI features may help shorten upgrade cycle
• A look at DCF and multiple valuation
• Apple rallies above $200 for the first time in history

Apple (AAPL.US) surged to fresh record highs this week in response to company's Worldwide Developers Conference held on Monday. Company previewed Apple Inteligence, an AI-focused platform, as well as a deal with OpenAI. Although hesitant at first, investors eventually welcomed the announcements and the stock made the biggest single-day jump in year and a half. Let's take a quick look at what was announced and how company's valuation looks like after recent surge.

Apple jumps to new record high on AI announcements

Apple held its Worldwide Developers Conference on Monday during the Wall Street cash session. Company made a number of AI-related announcements that were initially met with market scepticism - company's shares moved lower during the event and finished Monday'strading with a 2% drop. However, as more and more upbeat reviews of new features become to surface in the media, sentiment towards the company changed. Apple's stock surged 7% on Tuesday, marking the biggest single-day jump since November 2022 and jumping to fresh all-time highs above $200 per share. Strong demand for company's shares continued yesterday as well, with stock jumping almost 4% on Thursday.

Source: XTB Research

Will new AI features support business growth?

However, what did Apple announce, and will it be as big of a game-changer as market reaction suggests? Key things that Apple presented include:

• Apple Inteligence - new personal intelligence system for generative AI models with personal context added to enhance functionality of iPhones, iPads and Mac.
• New operating systems - Apple has also unveiled a new iOS18 system for iPhone and iPad as well as new operating systems for Mac, Watch and Vision products. New systems include new AI features.
• Deal with OpenAI - Apple also announced a partnership with OpenAI, that will integrate ChatGPT into iPhones, iPads and Macs. Partnership will include using ChatGPT in Apple's digital assistant Siri.

As one can see, event showed that Apple is going big on Artificial Intelligence, and does not want to miss on the ongoing tech trend, risking staying behind the competition. Partnership with OpenAI is welcome but financial terms behind it were not disclosed, but it's known that ChatGPT that Apple will offer on its devices will be free for users. Nevertheless, a broad rollout of new AI-supported operating systems is noteworthy. What is especially important is that backwards compatibility of those new systems will only be to iPhone 15 Pro. This is important as it has a chance to encourage iPhone users to replace their phones with newer models and therefore to shorten Apple's upgrade cycle. Products revenue accounts for 75-80% of Apple's total revenue, with iPhone revenue accounting for 50-60% of total revenue in recent quarters. Shorter upgrade cycle could help boost product sales and see Apple's total revenue growth reaccelerate.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Apple briefly overtakes Microsoft in market capitalization!

Apple is on three US stocks with a market capitalization exceeding $3 trillion US dollar. The other two are Microsoft and Nvidia. Thanks to this week's share price rally, Apple has briefly overtook Microsoft in terms of market capitalization to become the largest US public company by capitalization. However, bulls failed to hold onto all the gains made and stock corrected trimmed part of the gains before the end of Wall Street session yesterday. Apple is now worth $3.267 trillion, just around 0.3% less than Microsoft ($3.278 trillion). Nvidia is at the third place with a market capitalization of $3.080 trillion.

Source: Bloomberg Finance LP, XTB Research

A look at valuation

Now, let's take a look at Apple's valuation based on two well-known valuation models - Discounted Cash Flow method (DCF) and multiple valuation. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices. 

DCF

Let's start with one of the most popular fundamental models - Discount Cash Flow method (DCF). This model relies on a number of assumptions, including assumptions on sales growth and margins. Apple has been struggling to grow its revenue in recent quarter and years. However, we have decided to take an aggressive approach in valuing the company in order to capture growth potential coming from AI. We have decided to assume 7% revenue growth and 35% operating margin. Remaining variables were based on 5-year averages. We have assumed a 4% terminal revenue growth rate and 9% terminal weighted average cost of capital (WACC). Detailed forecast for 5 years were made, followed by terminal forecast.

While we have assumed above-average revenue growth and margins, valuation obtained via DCF model points to an intrinsic value of Apple's share of $176.92 per share - or around 17% below yesterday's cash close. Of course, full impact of AI-driven revolution in tech sector is hard to capture right now and this is reflected in the difference between current market price and fundamentals. This shows that there is a significant 'AI-premium' in the markets and company are at risk of correction later on in case they fail to meet expectations associated with new technology.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Apple's valuation compared to with its peers. As Apple is engaged in various activities, constructing a group of exact peers is hard if not impossible. We have created a peer group consisting of companies that are operating in one or more similar branches as Apple. Group includes - Dell Technologies, HP Inc, Super Micro Computer, Hewlett Packard Enterprise, Microsoft, Samsung and Sony. We have take a look at a number of multiples, including trailing and forward multiples. Multiples as well as mean, median and cap-weighted averages for the group can be found in the table below.

As one can see, there is quite significant volatility in multiples for Apple's peers. In most cases, valuations based on mean and median multiples are suggesting that Apple is overvalued at current prices. However, this is not the case with multiples weighted by capitalization, which are meant to better reflect company's size. In case of cap-weighted multiples, Apple actually looks undervalued by most measures (green tiles in the table below).

Source: Bloomberg Finance LP, XTB Research

A look at the chart

While sentiment towards Apple (AAPL.US) has been rather upbeat recently, with stock trading almsot 20% above late-April lows at the end of the previous week, it has significantly improve after this week's developer's conference. Stock surged 7% on Tuesday and followed with an almost-4% gain on Wednesday, jumping above the $200 per share mark for the first time in history. An intraday daily high was reached on Thursday near $220 per share. From a technical point of view, this area is marked with 161.8% exterior retracement of the downward correction that was launched on Apple stock in July 2023. Sentiment towards the stock is strong therefore it cannot be ruled out that gains will continue. Stock trades over 10% year-to-date higher and around 30% above late-April lows.

Source: xStation5