Explaining The Recent Apple Selloff, And Why The Stock Looks Undervalued

Apple’s (NASDAQ:AAPL) stock has seen a sharp sell-off in recent weeks, falling by close to 25% from all-time highs seen in October. The declines have largely been driven by reports that the company is cutting back production orders for the iPhone XS, XS Max, and XR, casting doubt on the uptake of the company’s newest devices. While the concerns are legitimate, considering that the iPhone accounts for about two-thirds of Apple’s revenues, we believe that Apple’s stock remains undervalued at current levels.

View our interactive dashboard analysis on What’s Driving Our $225 Price Estimate For Apple. You can modify any of our key drivers and forecasts to gauge the impact on the company’s valuation and arrive at your own price estimate. Our price estimate is about 25% ahead of the current market price.

iPhone Shipments Don’t Matter As Much

While the reports of production cuts could be a cause for concern, this is not exactly new for Apple. The company has on occasion misread demand  – for instance, it underestimated demand for the iPhone 6 and 7 and apparently overestimated demand for the 6S and X. Moreover, iPhone shipments have actually been sluggish for some time now, growing by less than 1.5% over the last two years, and declining compared to FY’15, when it saw an upgrade super-cycle driven by the iPhone 6. However, despite the sluggish shipments, iPhone revenue growth has been reasonably strong, driven by Apple’s strategy of raising prices. Apple’s iPhone ASPs have risen by about $160 over the last five years to $765, and roughly 70% of that increase has come in the last year alone, driven by the pricier models such as the iPhone X. We expect Apple to see modest iPhone revenue growth in the long run, driven by the ASP increases.

A Possibility Of Margins Looking Up

Apple’s margins could also see some upside in the medium term due to multiple reasons. For one, Apple has been driving significant growth in its high-margin services business. We estimate that the business will account for 16% of Apple’s revenues, up from just about 9% five years ago. As a meaningful portion of the business is commission-based (app sales, subscription and other fees), it could help to bolster Apple’s margins. Separately, the company could also see some tailwinds in the near term due to declining semiconductor prices. NAND prices are trending steadily lower, with major vendors adding 3D NAND capacity, allowing the company to better capitalize on its premium devices, while DRAM prices are also projected to fall from 2019 onwards.  Apple’s margins could also benefit from more mature production processes for the iPhone X form factor and more mainstream components used on the new XR. (related: The iPhone XS Max Could Be A Profit Machine)

Apple’s Valuation

Overall, Apple looks undervalued at the moment following the stock declines. The company currently trades at a forward P/E of just 13x (under 12x adjusted for net cash) based on our FY’19 EPS projection of $13.70 and the current market price of $177 per share as of Tuesday’s close. Its earnings yield also remains attractive in an increasingly high-interest rate environment, coming in at close to 8%. The company also has some earnings upside from its Services business and Other products division. While both segments together account for just about 20% of the company’s revenues, they have accounted for over 75% of Apple’s growth over the last three years, and the trend is likely to continue as products such as the Apple Watch and AirPods drive incremental growth. Apple’s aggressive share repurchases are also another factor that will power EPS growth, with the company spending more than $70 billion in FY’18 on buybacks.