- Apple will likely struggle due to a backdrop of weakening iPhone volumes.
- Things are worse for Apple than I had originally feared.
- I now anticipate much more weakness to Apple's sales and earnings.
- This is backed by analysis of historical trends in seasonality and the overwhelming evidence indicating softness of iPhone demand.
- As a result I have revised my Apple stock price target from $103.50 to $88.71.
Ironically, I’ve carried a contrarian viewpoint on Apple (NASDAQ:AAPL) for quite a while, which wasn’t well received by the investment community. Apple stock has finally capitulated below the $100 level and while I can acknowledge my stance on the stock dictated that it should have stabilized in the low-100s, we’ve received further confirmation from the component supply chain and ODMs that confirmed my fears over Apple's iPhone 6S/S+. In fact, the souring of sentiment got to a point that’s reminiscent of the stock sell-off we witnessed in 2012.
I figured this was going to happen. With a company that’s capable of shedding 50% of its valuation during the S-cycle, basic retracement techniques would indicate that a sentimentally driven environment could carry the stock below $90 before a pattern of stabilization does occur. Of course, I view Apple stock as fair valued below $100, but things will get even more interesting below $90. At that point virtually anyone can rationalize why Apple's valuation is phenomenal on an ex-cash/PE basis. But without further deterioration in Apple stock, one should wait for an investment catalyst.
Oppenheimer Co. released in a report on Jan. 8th 2016:
We are trimming estimates on the AAPL supply chain following two negative pre-announcements Thursday by CRUS and QRVO. The AAPL supply chain has been under pressure for the past month on fears of iPhone unit softness. While the cuts were well understood by investors, we believe their magnitude was surprising as iPhone shipments could be down 35%-plus to ~50M in March.
A reduction in excess of 35% in conjunction with overall weak volume in Q1’FY16 is more than enough to initiate a drop-off in full year sales north of 10%. In other words, even the financial model that I had created for my Seeking Alpha audience doesn’t fully capture the abrupt weakness to sales. The 35% decline is compared to prior year, so the sequential weakness will be more abrupt than in any other point in Apple’s recent corporate history. Furthermore, the preliminary pre-announcements further up the supply chain from CRUS and QRVO, and Foxconn’s flat comps in the month of November was the nail in the coffin. Instead of fighting these rumors it’s worth mentioning that many of these reports are coming from the companies themselves up the supply chain.
To help quantify the impact, I anticipate iPhone sales of 70m, 40m, 32.2m, 32.2m over the next four quarters. I don’t anticipate a sales recovery like other analysts because I view the seasonal patterns to be far more reliable. There’s usually never a Q3 or Q4 sequential comp improvement due to the softness of spring and summer. The reason for outspoken optimism are rumors pertaining to a C launch of the iPhone 6S variant, but I don’t anticipate a 4-inch device to significantly refresh demand or win over Android handset owners. In other words, Apple’s ability to gain market share due to its superior branding has come to a close. It owns more than 90% of the $600+ smartphone market and anything approaching $400 faces stiff competition from Android handset.
Besides, Apple isn’t going to price into the $400s because it will have a hard time communicating margins in the next two or three years due to its transition to three pricing tiers in its handset family. Usually Apple markets prior handset generations to gain lower-end share, so if anything a 6C would have a cannibalizing effect on 5s, 6/6+ models which compose 30% of the current device mix according to a UBS survey. Since the impact is more about commoditization than generating a substantial sales boost, I wouldn’t be so certain of a magical recovery once we transition into Q3’16.
When Apple released the 5C, demand was pretty tepid and the vast majority opted for the 5S line anyway. Likewise, if Apple were to move down the pricing tiers it would just mean prior models would generate fewer sales and the net impact could be revenue neutral rather than net revenue positive. I think consumers would still prefer the 6 lineup due to the larger screen, and while many believe in the loyalist theory. I think loyalists have already voted with their dollars by buying iPhone devices with larger screens with overwhelming satisfaction at the 4.7-inch screen variant.
So, what does this all translate to? I take on a more bearish stance due to the rapid change in developments. The overall resistance from analysts to model out continuing 35% year-over-year declines in Q3’16 and Q4’16 is a foreshadowing of further analyst revisions. I anticipate sales to drop by 15.64% as opposed to my prior estimate of a 5.82% decline to sales (both inclusive of 6 points of F/X impact) for FY’16. The decline to sales corresponds to an EPS figure of $7.64, which is below my prior estimate of $8.91 for FY’16. I still think I’m woefully optimistic because I can deduct gross margin percentage a bit further due to the mix shift to less profitable categories.
I revise my Apple stock price target of $103.50 to $88.71 (11.6x earnings). I don’t anticipate the stock to stay above $90 over the next 9-months and the outlook from its upcoming quarterly results will most likely fall below consensus. Sure, Apple might provide some reassurance in its upcoming quarterly earnings call, but my skepticism towards iPhone units upholds.
I sincerely believe the bar has been set too high. It seems Apple’s positioned to fail with limited viability of offering a better figure than consensus but then again, Apple could pull a magic rabbit. Nonetheless, there’s not a whole lot of convincing evidence to back up a compelling investment case going into earnings. Buyers should wait for re-entry below $90 not $100.