We Are Cutting Our Price Estimate For Apple, But Still Remain Bullish On The Stock

We are cutting our price estimate for Apple (NASDAQ:AAPL) from $225 per share to about $175 per share, on account of a sluggish iPhone business and headwinds in Greater China. While the company just cut its Q1 FY’19 revenue guidance in an unprecedented move, citing some of the above trends, we will focus this note on some near-to-medium term factors impacting our price revision and the key changes to our valuation model.

View our interactive dashboard analysis on What’s Driving Our $175 Price Estimate For Apple. You can modify key drivers to arrive at your own price estimate for the company.

iPhone Slowdown Driven Primarily By China

Apple’s iPhone business looks set to decline, primarily due to headwinds in China. Per market research firm Canalys, Apple’s share of the Chinese smartphone market contracted to about 7.8% in the first three quarters of CY’18 from a peak of 12.5% in CY’15. It’s very likely that sales will decline further, on account of the ongoing trade tensions with the United States and an increasing preference among Chinese customers for lower-priced, but well-specced local handsets from the likes of Huawei, Oppo, and Xiaomi. Moreover, Chinese customers spend much of their smartphone time on apps such as WeChat and Baidu which are platform agnostic, making it difficult to justify the hefty premium for an iPhone when they can get a largely similar app experience on a cheaper device.

The iPhone business is facing headwinds in other markets as well, due to lower than expected upgrades, amid consumer resistance to the $1000+ price points on the latest flagship models. Apple’s move to reduce prices on iPhone battery replacements last year is also likely to be causing customers to hold on to existing devices for longer. This has prompted the company to aggressively promote an iPhone trade-in program that gives existing iPhone owners generous buyback prices if they upgrade to its latest devices

Key Changes To Valuation Model

Considering the Chinese headwinds and weaker upgrade rates, we believe that Apple is likely to see iPhone shipments decline by about 5% over FY’19. Moreover, we believe that ASPs could also come under pressure over the next two years, due to a strengthening dollar and also due to a possibility that Apple could reduce the starting price of its flagship models over the next iPhone cycle. We believe that gross margins could also contract in the near-term due to currency effects and potential ASP declines. That said, Apple’s EPS is likely to continue to grow, coming in at about $13 per share in FY’19, driven by the company’s share repurchases. Our revised $175 price estimate for Apple values the company at about 13.5x projected FY’19 earnings.

Why We Still Remain Bullish On Apple 

We continue to believe that Apple stock is undervalued, with our revised price estimate coming in about 20% ahead of the current market price. Apple trades at a forward P/E of just about 11x (and below 10x adjusted for net cash) based on our FY’19 EPS projection of $13 and the current market price of $146 per share (Wednesday after-market price). Its earnings yield also remains attractive in an increasingly high-interest rate environment, coming in at close to 9%. While revenue growth is likely to be sluggish, the company could have some upside from its Other Products division (which includes Apple Watch and Airpods) and the Services business, which accounted for over 75% of the company’s revenue growth over the last three years. Moreover, the company’s commitment to becoming net-cash neutral over time implies continued share buybacks, which should help to boost EPS.