Stock of the week - Apple (12.09.2024)

Apple shares closed at $222.90 on Wednesday, despite the mixed newsflow. The stock is up 16.1% year-to-date, largely driven by excitement around the company's Apple Intelligence software unveiled at the Worldwide Developer Conference in May. The mixed reactions were caused by the company's recent product launches and ongoing regulatory challenges. This comes after Apple reported Q3 2024 results, faced a significant setback in its European tax case, and unveiled its new iPhone 16 lineup.

 

Key financial data (Q3 2024 guidance):

• Revenue: $85.5 billion, up 4.7% year-over-year (estimate: $84.4 billion)
• EPS: $1.40 (estimate: $1.35)
• iPhone revenue: $39.2 billion, down from $39.6 billion in Q3 2023 (estimate: $38.9 billion)
• Services revenue: $24.2 billion (estimate: $23.9 billion)
• Greater China revenue: $14.7 billion, down from $15.7 billion in Q3 2023 (estimate: $15.2 billion)

 

Quarterly earnings breakdown (Q3 2024 guidance):

• iPad revenue: $7.1 billion (estimate: $6.6 billion)
• Mac revenue: $7 billion, up from $6.8 billion in Q3 2023
• Wearables, home and accessories: $8 billion, down from $8.2 billion in Q3 2023

 

Key business metrics (Q2 2024):

• Gross margin: $42.27 billion, up 0.7% year-over-year (estimate: $42.01 billion)
• Cash and cash equivalents: $32.70 billion (estimate: $36.83 billion)
• Total operating expenses: $14.37 billion (estimate: $14.33 billion)

 

Key financial data:

• Revenue: $86 billion in Q3 2024, up 4.9% year-over-year
• iPhone revenue: $45.96 billion in Q2 2024, down 10% year-over-year
• Services revenue: $23.87 billion in Q2 2024, up 14% year-over-year

 

Quarterly earnings breakdown:

• Products revenue: $66.89 billion in Q2 2024, down 9.5% year-over-year
• Mac revenue: $7.45 billion in Q2 2024, up 3.9% year-over-year
• iPad revenue: $5.56 billion in Q2 2024, down 17% year-over-year
• Wearables, home and accessories: $7.91 billion in Q2 2024, down 9.6% year-over-year
• Greater China revenue: $16.37 billion in Q2 2024, down 8.1% year-over-year

 

Key business metrics:

• Gross margin: $42.27 billion in Q2 2024, up 0.7% year-over-year
• Cash and cash equivalents: $32.70 billion in Q2 2024

Apple, the tech giant known for its innovative products and services, delivered a mixed performance in its Q3 2024 results. While the company beat overall revenue and EPS estimates, it faced challenges in key areas such as iPhone sales and performance in the Chinese market.

The company's total revenue reached $85.5 billion, surpassing the estimated $84.4 billion and marking a 4.7% increase year-over-year. Earnings per share came in at $1.40, also beating the expected $1.35.

However, iPhone sales, a crucial metric for Apple, declined year-over-year to $39.2 billion from $39.6 billion in Q3 2023. Despite this drop, the figure still narrowly beat analyst expectations of $38.9 billion.

Apple's performance in Greater China, one of its most important markets, fell short of expectations. Revenue from the region came in at $14.7 billion, below the anticipated $15.2 billion and down from $15.7 billion in the same quarter last year. Despite this miss, Apple CFO Luca Maestri noted that sales are generally improving in the region, with record upgrades and better performance compared to the first half of the year.

A significant development for Apple is the recent EU court decision reinstating a €13 billion tax penalty. This ruling, stemming from a 2016 case, doesn't pose an immediate operational threat as Apple had already put the sum in escrow. However, it highlights the ongoing regulatory scrutiny the company faces, particularly in Europe.

The company recently held its annual product launch event, unveiling the iPhone 16 lineup and introducing Apple Intelligence, a groundbreaking AI technology integrated across its entire product ecosystem. Key features of the iPhone 16 and Apple Intelligence include:

1. New A18 chipset designed with TSMC's second-generation 3-nanometer technology, specifically built for AI processing
2. 6-core CPU with two performance cores, four efficiency cores, and a 16-core neural engine
3. 5-core GPU supporting hardware-accelerated ray tracing
4. Increased battery size to support enhanced AI capabilities
5. On-device generative AI processing, preserving user privacy and confidentiality
6. Intelligent writing tools for automatic rewriting of emails, documents, and messages
7. Automatic summarization of lectures, discussions, and documents
8. Enhanced Siri capabilities, integrating generative AI with device context awareness
9. Advanced photo library searching using intelligent image recognition
10. Custom photo video creation based on user preferences

Apple Intelligence is not backward compatible and will only run on the new iPhone 16 and last year's iPhone 15 Pro models, potentially driving a significant upgrade cycle over the next few years. However, there is a downside. Apple won’t release three recently announced features, including its flagship “Apple Intelligence” AI product, in the European Union in 2024 due to “regulatory uncertainties” stemming from the bloc’s Digital Markets Act antitrust regulation. The interoperability requirements apply to iPhones and iPads. But Macs are affected by the DMA because iPhone Mirroring allows users to replicate the screen of an iPhone on the screen of a Mac. The company said it will work with the European Union “in an attempt to find a solution that would enable us to deliver these features to our EU customers without compromising their safety.”

The Apple Watch Series 10 also received significant updates, including a 30% larger screen area, 10% thinner design, and faster charging capabilities. It incorporates new machine learning technologies for translation capabilities and sleep apnea testing, powered by a new S10 SiP with a 64-bit dual-core processor and a 4-core Neural Engine.

Looking ahead, Apple faces several challenges and opportunities:

1. Regulatory pressures, including potential changes to App Store policies and the risk to high-margin licensing fees from Google (mostly Europe and China)
2. Ongoing geopolitical tensions affecting its China business, which accounts for 18% of revenue
3. The potential for a significant upgrade cycle driven by Apple Intelligence and new hardware capabilities
4. Competitive advantages in on-device AI processing, which may be difficult for competitors to replicate in the short term
5. Potential growth opportunities in India, where sales increased 33% to nearly $8 billion over 12 months

 

While Apple's core business remains solid, the introduction of Apple Intelligence and the new iPhone 16 lineup represents a potential rebirth for the iPhone, launching a new era of capabilities and features. This could significantly impact Apple's future growth trajectory and market leadership. What might be also important for investors is to watch the number of preorders for new iPhones and pace of upgrading to new IOS. It might be a clear indicator of how interested the customers are.

 

Valuation:

We decided to base our assumptions on CAGR growth. We have assumed a 7% revenue growth and 40% operating margin for the 5 years of forecasts. Decision to make 5 years of detailed forecasts comes based on relevant data and historical averages.

As terminal value tends to account for a significant part of DCF valuation, especially with shorter periods of detailed forecasts, we have decided to take a very conservative approach here. For the terminal value calculations we have used a 5.5% revenue growth as well as 10.5% terminal WACC, up from 9.5% WACC used for 5 years of forecasts. The increase in terminal WACC comes from a point of Apple soon being a developed company which won't be able to grow that fast. 

Such a set of assumptions provides us with an intrinsic value of $206.38 per share which offers around 7.5% of possible downside to current market value. What is noteworthy is the fact that Apple stock price has only been three months above our valuation.

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

Next, let's take a look at how Apple compares with peers. We have constructed a peer group consisting of 5 companies, whose business model and growth might be similar to Apple: Microsoft, Alphabet, Amazon, Meta and Netflix. As can be seen Apple is above the mean for most of the multiples, however is in line with current peers P/E and slightly above forward P/E.

 

Source: Bloomberg Finance LP, XTB Research

We have calculated mean, median as well as cap-weighted multiples for the peer group. Three different Apple valuations for each of those multiples were later calculated. As one can see in the table below, the vast majority of those suggest that Apple shares are overvalued at current prices. However the multiple valuation also suggests that the downside for Apple might be limited.

 

Recommendations: Apple has 60 recommendations, with 40 "buy" and highest price of $300, 18 "hold", and 2 "sell" ratings with lowest at $180. The 12-month average stock price forecast is $246.23, implying a 10.6% upside potential from the current price.

 

Technical analysis: The price of Apple stocks is trading only 6.4% below all time high. It has also recently closed above 61.8% Fibonacci retracement at $221.49. We are also seeing a narrowing of Bollinger Bands, which might be an indication of possible breakout happening soon in the future. Currently the price action happens also near the 50 day SMA, which happened to be a strong support during large upside moves. RSI is making lower highs, for bulls to gain control the trendline must be broken. MACD is also trending lower. ADX might also be showing a potential for further positive price action. Lower Bollinger Band has acted previously as strong support and breaking it down resulted in fast upside reaction. However if this level is broken the price might test 38.2% and 23.6% Fibonacci retracements, which were not strong levels. For bears this might be an opportunity to test August lows at $197.93. Source: xStation