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Apple Looks Undervalued at These Levels: Here's Why
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Those of us who have seen Apple (AAPL - Free Report) growing unit sales quarter upon quarter despite what may be going on in the PC and smartphone markets, tend to overlook the fact that these things affect Apple too. And how well a company manages these factors relative to peers gives us a fair idea of how it’s really doing.
What’s Bitten the PC Market
As Intel (INTC - Free Report) CEO said earlier this year, the PC replacement cycle has gotten longer: "Four years was the average, now it has moved to about five to six years." And that’s mainly because older Intel Sandy Bridge processors are able to run the latest operating systems from Microsoft (MSFT - Free Report) . But there’s another reason: users in traditional markets have multiple devices taking care of most of their needs while the majority in emerging markets prefers smartphones, tablets, phablets, etc. since these take care of most computing needs.
Apple, which has a greater presence in traditional markets, didn’t do well in the September quarter. According to IDC, its worldwide Mac shipments fell 13.0% while U.S. shipments fell 13.2%. Apple lost notable market share.
Gartner’s numbers are slightly better: although worldwide shipments declined 13.4%, U.S. shipments were down 10.7%.
What About The Smartphone Market?
IDC estimates that the overall smartphone market grew a mere 1%, driven by Chinese brands OPPO, vivo and Huawei in that order. Samsung, Apple and the “other“ group declined with Apple declining the least.
The highlights of these results is that OPPO and vivo grew triple digits with strength in China because of offline marketing expertise and some Western European countries as part of new athletic sponsorships, according to IDC. OPPO has been more focused on international markets particularly India, while vivo has focused on tier 3 to tier 5 Chinese cities and also grown in India. New phone models are helping the Chinese players.
How Organized Is Apple?
From the above, two questions come to mind. Why is Apple losing share in the PC market? And second, will its smartphone decline continue, particularly in China?
On the call, management explained the seeming lack of demand for Apple devices:
“We ended the quarter below our four to five week target range for Mac channel inventory.”
and
“We also reduced channel inventory [of iPhones] by over 4 million units compared to about 0.5 million units a year ago, so sell-through was down by 8%.”
and also,
“By far, the largest portion of our global channel inventory reduction [of iPhones] was in Greater China.”
Most of us don’t buy a phone or a PC everyday so when an upgrade is in the offing, it would be natural to wait for it. This is even truer of enterprise buyers, i.e. the ones that buy in bulk. In Apple’s case, the Mac was due for an upgrade and the iPhone had just got a refresh.
What happens to older inventory? Is it a good idea to trash it, discount it, or clear it? Apple took the last option, which is what any management would do unless they were trying to manage the business from quarter to quarter. As a result, the company can now look forward to a seasonally stronger quarter where it can sell a good number of higher-ASP devices. We may expect some bulk purchasing as well because “corporate buyers reported a 94% satisfaction rate for iPad and a purchase intent of 68% for the December quarter.”
Management also quoted survey results from 451 Research indicating demand for iPhones in the U.S.:
Among corporate smartphone buyers, the latest survey measured a 95% iPhone customer satisfaction rating with purchase intention for this quarter at 75%. Among consumers, the customer satisfaction rating is 97% and purchase intent 65%.
Is Apple Really Sliding in China?
There are several well-publicized problems in China: the slowing economic growth, weakening consumer confidence, softer retail spending and a 7% depreciation in the Chinese yuan relative to the U.S. dollar since August of last year.
In the last quarter, Apple worked down its iPhone inventory in Greater China and continued to build its offline presence. This helps to build the brand versus Chinese players like OPPO, vivo, Huawei and Xiaomi. Apple, the fifth largest smartphone vendor behind the Chinese players, should also benefit from the Samsung Note fiasco. Note that China has favorable demographics in its rising middle class.
But since it isn’t a value player, its market share is likely to remain lower than the Chinese. Management promises a strong comeback in the fourth quarter and there’s a fair chance of that happening given the iPhone 7 and lean inventories. China is not an easy market to call, however, because of the strong domestic players but we should at least wait another quarter before determining that Apple’s market share losses are permanent.
Is Apple Losing The India Opportunity?
In India, Apple has tied with Reliance Jio, which is rolling out a first of its kind all-IP network, extending 4G coverage to 18K cities and 200K villages. According to their alliance with Apple, they're offering a free year of service to purchasers of new iPhones with Apple providing the guarantee of a great iPhone experience on their network.
For those who haven’t heard of Reliance Jio, the telecom company exited the trial phase of its 4G service on Sep 5 after a massive publicity campaign during which it gave away tons of data. Its goal is to accumulate 100 million customers as soon as possible and the company has already ensnared several million. According to the latest available data from IDC, Jio is now the fifth largest smartphone vendor in India, behind Samsung, Micromax, (Lenovo+Motorola) and Intex.
India has positive demographics with a fast-growing population of which 50% is under 25 (according to Tim Cook). The 4G network is exactly where Apple needs to be, so it’s headed in the right direction.
Apple has been selling in India through online channels because of regulatory hurdles to setting up its branded stores. There may be some progress in this area as well as the company has increased investment in the country, setting up a first-of-its-kind software development center in Hyderabad.
The Next Growth Market
Too often we get bogged down with current businesses and fail to recognize emerging opportunities. But a company with vision plans for the future, which is what Apple has been doing with its services business.
Apple has repeatedly pointed to its installed base that continues to grow thanks to the number of first-time buyers and switchers. Maybe it’s time we started to take notice because a larger installed base means the scope to sell more services. Service revenue grew 24% in the last quarter. App store remains the star, generating 100% more global revenue than Alphabet's (GOOGL - Free Report) Google Play in the September quarter according to App Annie, but Apple Pay transaction volumes are rising “dramatically,” says Apple.
All hardware makers are supplementing with services because hardware innovation is increasingly tied to related services. Apple made an extremely smart move tying up with IBM (IBM - Free Report) and it is currently building its partner ecosystem to drive corporate sales.
Today, you can buy an Apple share at 12.2x its earnings (P/E), but you’d have to pay 45.3x for other shares in the industry (on average). The S&P 500 average is lower than the industry, so you can buy a share for 18.1x earnings.
This also means that we would be paying 1.28x its earnings growth (PEG) compared to 3.81x PEG for the industry.
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Apple Looks Undervalued at These Levels: Here's Why
Those of us who have seen Apple (AAPL - Free Report) growing unit sales quarter upon quarter despite what may be going on in the PC and smartphone markets, tend to overlook the fact that these things affect Apple too. And how well a company manages these factors relative to peers gives us a fair idea of how it’s really doing.
What’s Bitten the PC Market
As Intel (INTC - Free Report) CEO said earlier this year, the PC replacement cycle has gotten longer: "Four years was the average, now it has moved to about five to six years." And that’s mainly because older Intel Sandy Bridge processors are able to run the latest operating systems from Microsoft (MSFT - Free Report) . But there’s another reason: users in traditional markets have multiple devices taking care of most of their needs while the majority in emerging markets prefers smartphones, tablets, phablets, etc. since these take care of most computing needs.
Apple, which has a greater presence in traditional markets, didn’t do well in the September quarter. According to IDC, its worldwide Mac shipments fell 13.0% while U.S. shipments fell 13.2%. Apple lost notable market share.
Gartner’s numbers are slightly better: although worldwide shipments declined 13.4%, U.S. shipments were down 10.7%.
What About The Smartphone Market?
IDC estimates that the overall smartphone market grew a mere 1%, driven by Chinese brands OPPO, vivo and Huawei in that order. Samsung, Apple and the “other“ group declined with Apple declining the least.
The highlights of these results is that OPPO and vivo grew triple digits with strength in China because of offline marketing expertise and some Western European countries as part of new athletic sponsorships, according to IDC. OPPO has been more focused on international markets particularly India, while vivo has focused on tier 3 to tier 5 Chinese cities and also grown in India. New phone models are helping the Chinese players.
How Organized Is Apple?
From the above, two questions come to mind. Why is Apple losing share in the PC market? And second, will its smartphone decline continue, particularly in China?
On the call, management explained the seeming lack of demand for Apple devices:
“We ended the quarter below our four to five week target range for Mac channel inventory.”
and
“We also reduced channel inventory [of iPhones] by over 4 million units compared to about 0.5 million units a year ago, so sell-through was down by 8%.”
and also,
“By far, the largest portion of our global channel inventory reduction [of iPhones] was in Greater China.”
Most of us don’t buy a phone or a PC everyday so when an upgrade is in the offing, it would be natural to wait for it. This is even truer of enterprise buyers, i.e. the ones that buy in bulk. In Apple’s case, the Mac was due for an upgrade and the iPhone had just got a refresh.
What happens to older inventory? Is it a good idea to trash it, discount it, or clear it? Apple took the last option, which is what any management would do unless they were trying to manage the business from quarter to quarter. As a result, the company can now look forward to a seasonally stronger quarter where it can sell a good number of higher-ASP devices. We may expect some bulk purchasing as well because “corporate buyers reported a 94% satisfaction rate for iPad and a purchase intent of 68% for the December quarter.”
Management also quoted survey results from 451 Research indicating demand for iPhones in the U.S.:
Among corporate smartphone buyers, the latest survey measured a 95% iPhone customer satisfaction rating with purchase intention for this quarter at 75%. Among consumers, the customer satisfaction rating is 97% and purchase intent 65%.
Is Apple Really Sliding in China?
There are several well-publicized problems in China: the slowing economic growth, weakening consumer confidence, softer retail spending and a 7% depreciation in the Chinese yuan relative to the U.S. dollar since August of last year.
In the last quarter, Apple worked down its iPhone inventory in Greater China and continued to build its offline presence. This helps to build the brand versus Chinese players like OPPO, vivo, Huawei and Xiaomi. Apple, the fifth largest smartphone vendor behind the Chinese players, should also benefit from the Samsung Note fiasco. Note that China has favorable demographics in its rising middle class.
But since it isn’t a value player, its market share is likely to remain lower than the Chinese. Management promises a strong comeback in the fourth quarter and there’s a fair chance of that happening given the iPhone 7 and lean inventories. China is not an easy market to call, however, because of the strong domestic players but we should at least wait another quarter before determining that Apple’s market share losses are permanent.
Is Apple Losing The India Opportunity?
In India, Apple has tied with Reliance Jio, which is rolling out a first of its kind all-IP network, extending 4G coverage to 18K cities and 200K villages. According to their alliance with Apple, they're offering a free year of service to purchasers of new iPhones with Apple providing the guarantee of a great iPhone experience on their network.
For those who haven’t heard of Reliance Jio, the telecom company exited the trial phase of its 4G service on Sep 5 after a massive publicity campaign during which it gave away tons of data. Its goal is to accumulate 100 million customers as soon as possible and the company has already ensnared several million. According to the latest available data from IDC, Jio is now the fifth largest smartphone vendor in India, behind Samsung, Micromax, (Lenovo+Motorola) and Intex.
India has positive demographics with a fast-growing population of which 50% is under 25 (according to Tim Cook). The 4G network is exactly where Apple needs to be, so it’s headed in the right direction.
Apple has been selling in India through online channels because of regulatory hurdles to setting up its branded stores. There may be some progress in this area as well as the company has increased investment in the country, setting up a first-of-its-kind software development center in Hyderabad.
The Next Growth Market
Too often we get bogged down with current businesses and fail to recognize emerging opportunities. But a company with vision plans for the future, which is what Apple has been doing with its services business.
Apple has repeatedly pointed to its installed base that continues to grow thanks to the number of first-time buyers and switchers. Maybe it’s time we started to take notice because a larger installed base means the scope to sell more services. Service revenue grew 24% in the last quarter. App store remains the star, generating 100% more global revenue than Alphabet's (GOOGL - Free Report) Google Play in the September quarter according to App Annie, but Apple Pay transaction volumes are rising “dramatically,” says Apple.
All hardware makers are supplementing with services because hardware innovation is increasingly tied to related services. Apple made an extremely smart move tying up with IBM (IBM - Free Report) and it is currently building its partner ecosystem to drive corporate sales.
Still Not Convinced?
Let’s see some valuation metrics.
APPLE INC Price and EPS Surprise
APPLE INC Price and EPS Surprise | APPLE INC Quote
Today, you can buy an Apple share at 12.2x its earnings (P/E), but you’d have to pay 45.3x for other shares in the industry (on average). The S&P 500 average is lower than the industry, so you can buy a share for 18.1x earnings.
This also means that we would be paying 1.28x its earnings growth (PEG) compared to 3.81x PEG for the industry.
While most brokers have a positive recommendation on Apple shares, its near-term uncertainties have fetched Apple a Zacks Rank #3 (Hold).You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Confidential from Zacks
Beyond this Analyst Blog, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>