Should You Buy Apple Stock After The Recent Correction?

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Apple stock (NASDAQ: AAPL) dropped -5.5% over the last five trading days and has underperformed the S&P 500 which fell by a little over -1% during the same period. The stock is also down by almost -10% over the last 21 trading days. The recent sell-off comes on the back of rising bond yields, which have taken some sheen off large-cap tech stocks that were viewed as a safe haven through Covid-19. Moreover, investors are likely betting that the economic recovery will pick up as Covid-19 vaccines are administered, moving funds to more cyclical sectors.  Apple stock, which is up almost 70% over the last 12 months, is likely a source of liquidity driving this shift. Now, is Apple stock set to decline further or should we expect a recovery? We believe that there is a 61% chance of a rise in Apple stock over the next month (twenty-one trading days) based on our machine learning analysis of trends in the stock price over the last five years. See our analysis on AAPL Stock Chances Of Rise for more details.

Overall, we remain neutral on Apple stock at current levels. While Apple’s current earnings multiple looks high relative to historical levels, trading at about 28x projected 2021 earnings, and up from levels of around 18x at the end of 2017, growth is likely to pick up considerably this year. Revenues are projected to jump by a solid 21%, per consensus estimates, driven by strong demand for the iPhone 12, continued growth in the services business, and rising volumes for other computing products such as iPads and Macs. Apple’s margins have also been trending higher, driven by a more favorable product mix and better economies of scale.

[Updated 2/2/2021] What’s Driving Apple’s Margins Higher? 

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Apple (NASDAQ:AAPL) had a solid Q1 FY’21, posting record Revenues that topped $110 billion led by the new 5G iPhones. Apple’s Operating Margins also soared by a remarkable 220 basis points year over year to about 30.1%. Can Apple sustain these margins going forward? Let’s take a closer look at what drove Apple’s Products and Services Gross Margins and Operating Expenses to find out.

Apple’s Product Gross Margins, or the profits it makes after accounting for direct costs related to making its iDevices, computers, and accessories, rose by around 90 basis points year over year to 35.1%. Although we actually expected margins to face pressure on account of higher costs relating to 5G components on the new iPhones, Apple significantly beat our margin expectations, driven by a couple of factors. Firstly, Apple has a certain level of fixed costs in its product cost structures and with the product Revenue soaring by about 21%, it benefited from some leverage gains. Secondly, Apple’s product mix has been more favorable than previous quarters, with Apple nudging customers towards “Pro” versions of its devices, which likely have thicker margins.  In fact, Apple raised the price of its iPhone 12 versus last year’s iPhone 11, making its iPhone 12 Pro models (priced at $1,000 and up) look like better value compared to last year.

Apple’s Services business also saw Gross Margins soar to around 68.4%, an increase of around 400 basis points versus last year. Services Revenue grew by a strong  24% year-over-year, likely enabling better-fixed cost absorption.  Apple also likely saw a large percentage of commission-driven revenues such as App sales and subscriptions, which are much more profitable. Apple’s operating expenses rose by just about 12% year-over-year compared to total Revenues which expanded by 21% and this was also a factor that drove its Operating Margin gains, in addition to the Gross Profit gains.

Our dashboard Breaking Down Apple’s Services Revenue estimates the revenue figures for AppStore, Apple Music, Apple TV+, iCloud, Third-party Subscriptions, Licensing, Apple Care, and Apple Pay.

So can Apple sustain margins at these levels? We think so. Apple’s 2021 Revenues are projected to jump by a solid 21%, per consensus estimates, likely growing faster than Apple’s cost base. Moreover, the full impact of the new iPhone 12 is only likely to be seen in the coming quarters, as production picks up and the devices see full quarters of availability. For perspective, the device went on sale only about 3 to 4 weeks into Q1’FY21, with popular models remaining short supplied.

[1/25/2021] Will The iPhone 12 Deliver For Apple?

Apple (NASDAQ:AAPL) is slated to publish its Q1 FY’21 earnings on January 27, reporting on a quarter that saw the launch of its much anticipated 5G iPhone 12. We expect Revenues to come in at about $100 billion for the quarter, growing by about 9% versus last year, with EPS likely to grow by about 7% to around $1.35 per share. Our estimates are marginally below the consensus. So what are the key trends that are likely to drive earnings? Firstly, Revenues should see a bump driven by strong demand for the 5G iPhones, which saw multiple models remain back-ordered through the holidays. Apple should also see higher average selling prices for the iconic smartphone, as it raised base pricing on the iPhone 12 versus the iPhone 11, while nudging customers toward the more premium iPhone Pro models (priced at $1,000 and up), which appear to be a better value compared to last year. Apple’s Services business is also likely to have had its strongest quarter yet, driven by the App Store. In fact, Apple provided a data point indicating that between Christmas Eve and New Year’s Eve, a total of $1.8 billion was spent on apps, up 27% versus last year. [1] App sales growth over the same period last year was about 16%. That said, Apple’s margins could see some pressure, as the new iPhones are likely to be more expensive to produce compared to last year as 5G components are pricier.

Apple stock has rallied by about 65% over the last 12 months, driven largely by anticipation surrounding the 5G iPhones. Apple stock now trades at 33x projected EPS, making it look pricey compared to historical levels. The Q1 FY’21 earnings should give investors a good sense of how the device is faring and could be key to Apple’s stock trajectory in the near-term. See our pre-earnings analysis Apple Earnings Preview: Will Apple Beat Expectations? for more details on Apple’s recent performance and what’s driving its valuation.

[12/9/2020] Apple’s Services Will Overtake The iPhone By 2024

Apple’s (NASDAQ:AAPL) Services business is likely to emerge as its most profitable (and valuable) business within the next four years, likely eclipsing even the iPhone –  which is seen as one of the most lucrative consumer products of all time. Here’s how we expect this to play out. We expect Services sales to grow at a rate of about 11% a year (down from a rate of 22% each year over the last 4 years) to $81.5 billion in FY’24, driven by the continued growth of the AppStore and subscription services. On the other hand, we expect iPhone Revenues to grow at an average rate of about 5% each year over the next four years to about $167 billion (iPhone Revenue remained almost flat between 2016 and 2020). Now Apple’s services have much thicker margins compared to hardware products. Over FY’20, Apple’s product Gross Margins stood at 31.5% versus about 66% for Services. If we assume that margins remain flat at current levels, Services Gross Profits would stand at about $54 billion in FY’24, compared to about $53 billion for the iPhone. In fact, Operating Profits could actually be much higher for Services, considering that much of Apple’s Services sales come via commissions, with little marketing or development expenses involved.

Our dashboard Breaking Down Apple’s Services Revenue estimates the revenue figures for AppStore, Apple Music, Apple TV+, iCloud, Third-party Subscriptions, Licensing, Apple Care, and Apple Pay.

However, there are a few caveats. Firstly, Apple’s Service business is quite dependent on fees Google pays Apple for being the default search engine on its iDevices (an estimated 20% of Services Revenue, and a larger percentage of profits). There’s a possibility that the U.S. Justice Department’s antitrust lawsuit against Google could jeopardize these payments, hurting Apple’s services growth. Secondly, Apple is increasingly investing in content production with services such as AppleTV+ and these offerings could also have lower margins.

So what does this mean for Apple stock? Internet services led companies have typically commanded higher valuation multiples compared to hardware plays on account of their thicker margins, and associated platform related lock-ins. However, in Apple’s case, this is likely already baked into its valuation. Apple’s trailing P/E multiple has soared and almost doubled over the past year to levels of around 38x currently – which is in line with other Internet players such as Alphabet.

[Updated 11/23/2020] What’s The Impact Of The AppStore Commission Cut?

Last week, Apple (NASDAQ:AAPL) indicated that it would be cutting its commissions on app sales and in-app purchases from 30% to 15% for smaller developers, who earn less than $1 million annually from the AppStore. Apple has been facing significant criticism that its AppStore practices hurt smaller developers and tech giants, including Apple, face increasing scrutiny from regulators regarding their market power. This move should help Apple’s image to a large extent. App analytics company Sensor Tower estimates that about 98% of the developers that pay Apple commissions will benefit. [2]

However, will reducing commissions by half impact the performance of Apple’s highly lucrative and fast-growing Services business? After all, the AppStore is estimated to account for roughly a third of Apple’s Services Revenue. Not really. Apple earns a bulk of its AppStore revenue from the largest developers, with Sensor Tower indicating that developers who benefit from this program accounted for under 5% of App Store revenues last year. Moreover, the discounted fee will only apply until developers cross the $1 million threshold, after which Apple will bill them at the higher 30% commission rate.

[Updated 8/17/2020] How The Epic Lawsuit Impacts Apple

Last week, Epic Games sued Apple (NASDAQ:AAPL) for antitrust violations, after its popular Fortnite game was removed from the AppStore shortly after Epic let players bypass Apple’s in-app purchase system, avoiding the 30% commission on sales. Although Apple has had spats with developers in the past, the Epic lawsuit is noteworthy for a couple of reasons. Firstly, the Epic lawsuit comes at a time when tech giants, including Apple, have been facing increasing scrutiny from regulators regarding their market power. Secondly, Apple is more dependent on its Services business than ever before, with hardware growth slowing (profits from Services grew 5x as fast as hardware profits over the first three-quarters of FY’20), and Epic’s lawsuit targets Apple’s commissions, which we estimate are Apple’s single most profitable revenue stream.

Apple made roughly about $360 million in commissions from Fortnite over the last two years per Sensor Tower –  a relative drop in the bucket for Apple which pulled in $260 billion-plus in revenues last year. [1] However, if Epic sees a favorable judgment, and if Apple is forced to reduce its commissions or change the terms of its AppStore, this is very likely to set a precedent, causing other developers to demand similar terms.

So what could be the financial impact of Apple reducing commissions across the board? Apple takes a 30% cut on App sales and subscriptions (15% from the second year of subscriptions) and we estimate that total commission revenues stood at almost $20 billion in FY’19 (out of a total of about $46 billion in Services Revenue).  If Apple reduced commissions to say 20% from 30%, it would reduced total commissions by about $7 billion to roughly $13 billion. Although the revenue impact would be limited for Apple (under 3% of Apple’s Total Revenue) the impact on profits would be more pronounced given that commissions are likely to be almost entirely profit. We estimate that Apple’s Operating Income would be about 10% lower if commissions were reduced, considering Apple posted about $64 billion in Operating Income in FY’19.

Now commissions of 30% are actually pretty standard across the industry – Alphabet’s (NASDAQ:GOOG) Google, which also faces a similar lawsuit from Epic, as well as Microsoft and Amazon, charge roughly the same fees on app sales on their respective market places. However, Apple has the most to lose from this given the sheer scale of its business. AppStore revenues are roughly twice as large as Google’s Playstore.

While Apple stock may have moved, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how the stock valuation for Alphabet vs. Vertex Pharmaceuticals shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.

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Notes:
  1. Apple Press Release []
  2. New York Times []