- Apple's Q4 earnings call revealed 3 major subtle yet critical growth areas for the company.
- These growth areas imply that Apple's next quarter will be better than expected.
- This expectation makes Apple's stock an attractive buy that investors should consider.
Apple Inc. (NSDQ:AAPL) last week reported revenues ($46.9 billion) and gross margins (38% yoy growth) that came in at the higher end of the management's guidance. As pointed out in an earlier article, Apple's quarter was actually much better because it beat "raised" estimates.
But three things really stood-out for me:
- Apple's gain from Samsung is going to show in Apple's next quarterly results.
- Apple will extract more value from new customers far beyond the price of the iPhone.
- The stock could see an upward reversal when the market realizes that Apple is too promising to be trading at the current depressed valuations.
Samsung's Gift To Apple
Samsung's amazing gift to Apple and the promising growth prospects in China: Tim Cook has been known to keep promises and keep investors informed.
- Samsung's loss is looking like Apple's gain come next-quarter.
Think back to August of 2015 when Tim Cook decided to calm Apple investors regarding Apple's growth in China. Tim Cook's response was provoked by the fact that in just 17 days, China's Shanghai Composite Index (lost 21.5% in value or $1.2 trillion) lost the equivalent of the entire market capitalization of Spain's four stock exchanges.
This unprecedented decline made investors wary of Apple's prospects in China. To ease the tension, Tim Cook wrote an email to Jim Cramer saying that iPhone activations have accelerated in China despite growing economic concerns. Apple performed extremely well in China a month later during Apple's quarter end.
This background is critical because Apple's recent Q4 also gave a rare glimpse into these subtle, yet critical directions for Apple moving forward.
The first one has to do with the momentum of the iPhone 7 Plus which might likely be due to the vacuum created by the 'burning' Samsung Galaxy Note 7. Luca said that "the demand for iPhone 7 and 7 Plus has significantly outpaced supply, particularly on iPhone 7 Plus." This could be because of the burning incidents of the Samsung Galaxy Note 7. An Apple advantage which could prove lucrative going forward.
This point was further reiterated when Luca Maestri said that even though iPhone sales in Greater China declined during the quarter, the initial customer response to iPhone 7 and 7 Plus is giving Apple the "confidence" that their December quarter performance in China will be significantly better on a YoY basis than their September quarter results showed. (See also: What's Next For Apple Inc. After It Scales Down Project Titan)
#2: The power of The Apple Ecosystem
Apple has a giant, fast growing start-up inside it which proves the value of its ecosystem.
- Apple's ecosystem is more lucrative than the credit which market is giving it .
Tim Cook mentioned that 2016 saw "more customers switch from Android to iPhone than ever before."
This switch is advantageous because as more people switch to Apple, the more product portfolio the company has to sell to each of its current and new customers. Thus creating more growth avenues for the future.
For example, in Q4, Apple saw its Services business grow by an amazing 24% yoy. Apple Services is a collective name for Apple's Internet Services, AppleCare, Apple Pay, licensing and other services as shown in the table below. Apple expects Apple Services "to be the size of a Fortune 100 company in fiscal 2017", representing how popular and adaptable the Apple ecosystem is becoming. The popularity of Apple Services can also be seen from the 43% YoY growth in Apple Store revenue.
(Source: Apple's Q4 Earnings Results)
Apple Services is important because it shows that Apple has the ability to extract more money from each new customer. Meaning that Apple's Customer Lifetime Value ("CLV" - net profit gained from each customer for the entire duration of the relationship) is higher because it has created an ecosystem of products that work well together and thus entices new and existing customers to also buy its other products. For example, since being launched, Apple Pay transactions were up nearly 500% YoY. With Apple Pay built into Safari, countless websites are bringing Apple Pay to their customers. Tim Cook mentioned that "Our major partners tell us that Apple Pay shows the highest conversion rate than any digital wallet."
Meaning that when more people switch from android, the value to Apple transcends the value of the iPhone. This is why the growth in Apple Services should be seen as a huge growth booster for Apple in the near future.
In addition, if you are an Apple customer, you are more likely to be the happiest phone owner than anyone who owns any other phone. According to the American Customer Satisfaction Index ("ACSI") report, Apple scored 81 out of 100 while Samsung followed behind with 80 out of 100 (a number likely to have changed after the Samsung Galaxy Note 7 disaster). This implies that Apple customers are likely to stay with Apple for a long time. This is good for Apple because it means that it will be able to extract more value from its customers overtime, as compared to its competitors. (See also: The Stock Market Won't Crash And These Charts Prove It)
#3: Buybacks, Acquisitions and Valuations
Apple is likely to make an accretive acquisition.
- Apple's value continues to increase but valuations remain depressed until the market realizes the discrepancy.
Apple returned over $9 billion to investors during the September quarter alone: 3.1 billion in dividends and equivalents, $3 billion through repurchases of 28.6 million Apple shares through open market transactions and launched a new $3 billion ASR (Accelerated Share Repurchase) programme, resulting in initial delivery and retirement of 22.5 million shares.
This trend of Apple returning money to shareholders is likely to continue this quarter. One such notable way Apple could do this is by buying back more of its own shares. This could happen because the stock is attractive.
Think about it. Apple is a $600 billion company which is still capable of sustaining Gross margins of 38% as of Q4 2016 and yet it still trades at a forward price to earnings ratio of 12.8, which is ~49% below the S&P 500 forward price to earnings ratio.
(Source: Morningstar - Apple Inc.)
Aside from current valuations, there is more upside to Apple based on the fact that it might have some lucrative products in its pipeline. Like Tim said,"there's clearly some amount of R&D that are on products ,that today are in the development phase and have not reached the market, and so that's a part of it. And we feel really great about the things that we've got." This means that Apple could have an element of surprise from any of these products which could boost AAPL stock higher.
It is my contention that Apple has more value than the market is giving it. They have consistently shown their ability to grow, innovate and succeed in markets where most companies have failed. Their brand is powerful, making their ecosystem the most attractive. If we add Samsung's gift to Apple, Apple's ability to grow its CLV and the depressed valuations, Apple stock is clearly worth buying.
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