Apple (AAPL – Free Apple Stock Report) has been in the headlines a lot lately, and not always for the best reasons. Rather than stories touting its product innovation and legendary growth trajectory, much of the recent news focused on the company’s iPhone encryption battle with the U.S. government. That battle, closely watched by the Silicon Valley community and civil rights advocates, has been resolved temporarily, with the FBI successfully retrieving data from the San Bernardino terrorist’s iPhone without the help of Apple’s engineers. But the encryption issue will most likely rear its head again in the not-too-distant future, given the push by law enforcement at the federal and state levels to access suspects’ digital information. And further legal battles could well create an overhang in the stock, as this latest one seemed to do, at least marginally. In the meantime, concerns about the iPhone franchise, the main driver of the company’s results these days, persist during the early stages of fiscal 2016 (year ends September 24th), which also seems to be weighing on AAPL shares. This may explain why the new Dow component looks so inexpensive on a price-to-earnings basis, trading at roughly 12 times the consensus share-net view (of $9.07) for this year. So, are investors wise to remain on the sidelines at this juncture? Or is now an opportune time for patient buy-and-holders to take the plunge? In this brief article, we will attempt to address these questions by taking a look at Apple’s business and performing a SWOT analysis of the tech heavyweight, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
Apple Inc., founded in 1976 and a member of the prestigious Dow 30 since March of 2015, manufactures and markets personal computers, digital music players, mobile communications devices, and a host of related services, peripheral goods, and software solutions. Products are sold online, through third-party resellers and wholesalers, and via the company’s own network of over 460 retail outlets worldwide. In product terms, the iPhone remains Apple’s most important offering by far, accounting for about two-thirds of total sales and three-quarters of gross profits. And, geographically speaking, the company still generates most of its revenue at home, with sales in the Americas making up 40% of the top line last year. That said, Greater China is Apple’s fastest-growing market, registering a hefty sales gain of 84% in fiscal 2015.
The iPhone: Sales of the revolutionary smartphone have undoubtedly cooled off a bit lately, inching just 0.4% higher in the December period. The franchise remains a cash cow for the company, however, and the essential part of its rich ecosystem of products and services. What’s more, the iPhone still looks to have plenty of room to grow, notwithstanding the recent slowdown. In fact, we see unit sales increasing at (at least) a high-single-digit average annual clip through late decade, despite heightened competition from Android-powered devices and uneven business conditions in several emerging markets overseas. (Android is a mobile operating system developed by Alphabet (GOOG).) Growth should be driven by a strong replacement cycle, as the majority of iPhone users have yet to upgrade to the latest models, the 6S and 6S Plus (they debuted in September 2015). In addition, the introduction of the iPhone 7 (anticipated in time for the holiday shopping season) ought to be a big catalyst, especially with the higher end of the smartphone space showing renewed signs of strength. And we look for the iPhone to wrest share from Android, both in the premium category (where Samsung’s Galaxy S series has had a fair amount of success) and in the low- to mid-range segment of the market (where customers are likely to be attracted to the iPhone’s rich feature set).
China: Economic conditions have softened a bit in China lately (the GDP target for this year is 6.5%-7%, versus an average annual growth rate of 7.8% for the years 2011-2015), but Apple has yet to experience any ill effects from the relative slowdown. On the contrary, growth in that part of the world remains robust, with sales in Greater China rising 14% on a year-over-year basis in the December quarter against some very tough comparisons. Even better, we expect the good times to continue to roll, thanks to market-share advances that will probably be aided by less-expensive iPhone models. Notably, the company just announced a new 4-inch iPhone SE that will start at a competitive price point of $399. This is less pricey than the flagship 6S and 6S Plus offerings (they start at around $650). And we would expect the new SE edition to help propel Apple’s share of China’s smartphone market past the current 25% mark. (Early preorders of the iPhone SE in China have reportedly been quite strong.)
Shareholder-Friendly Policies: While AAPL shares may be in the doldrums, easily lagging the S&P 500 Index over the past year, the company continues to generate a lot of cash, to put it mildly. In fact, Apple now has a cash hoard of about $215 billion on its books (including long-term marketable securities). And we would expect this figure to continue to swell, even if earnings take a slight dip this year before heading back up through the 2019-2021 time frame. This should enable the company, having repurchased 15% of the outstanding share base over the past three years, to remain fairly active on the stock-buyback front going forward. Moreover, we envision steady increases to the cash dividend over time, with the quarterly payout likely to be hiked in late April from $0.52 to $0.57 a share. This would bring the stock’s yield to over 2%.
The iPad: The tablet line has probably been the biggest disappointment in recent years, failing to find a place in the hearts of Apple enthusiasts that already have an iPhone and a Mac. Things only seem to be getting worse for the in-between form factor, too, with iPad unit sales slumping 25% during the fiscal first quarter. Part of this erosion may well be due to the launch of larger-display iPhone models. (The 6S Plus has a 5.5-inch screen.) Still, the company hopes that efforts to penetrate the large enterprise market will help to reverse the fortunes of this struggling franchise. To this end, Apple is currently developing new business applications in partnership with International Business Machines (IBM – Free IBM Stock Report). It’s also unveiled a new 9.7-inch iPad Pro that is being touted as a powerful PC replacement for the workplace. Just how successful the new device will be displacing aging business-oriented PCs remains to be seen. Yet, the latest iPad Pro seems to be priced right, more expensive than the iPad Air 2 but roughly $200 cheaper than the original iPad Pro. And the product features greater storage capacity, which may prompt businesses to take a closer look.
Premium Pricing: The high prices that Apple’s products command, long a blessing for the bottom line, are a credit to the company’s innovative flair and brand-building skills. They can be a hindrance when it comes to penetrating emerging countries, however, where GDP per capita is far less than it is in mature markets like the U.S. and Europe. This explains, in large part, why cheaper Android devices, many of which are made by low-cost Asian OEMs, have done so well in the developing world. And the price differential could be more of a problem down the road, compelling Apple to rethink its premium-focused strategy.
Macs: The traditional Mac computing line has been lost in shuffle over the past decade, as the iPhone burst onto the scene and became a remarkable earnings catalyst for Apple. The Mac franchise remains a slow-and-steady grower, however. And we would expect trends to stay positive, notwithstanding the secular decline in the broader PC sector. Indeed, we envision the company’s share of the global PC market moving up from the high single-digits (it’s close to 7% at present), as efforts to enhance the ecosystem help the company lure customers from rivals Lenovo, Hewlett-Packard (HPQ.D), and Dell. A paring of the product portfolio, which appears to have expanded too much in recent years and lost some of its focus in consumers’ minds, should also drive Mac sales to new heights.
The Apple Watch: This is still a new product for Apple, so the jury remains out, to some degree. That said, we expect it to be a nice contributor to the top and bottom lines once retail distribution improves and developers get on board with more applications (e.g., health and fitness tracking programs) for the new-age timepiece. The wearable device market is certainly buoyant, as can be seen in the strides made by newly public Fitbit (FIT). And the Apple Watch should only add to consumers’ interest in the category.
Services: Beyond sales of digital music and apps, newer services businesses, including Apple Pay, Apple Music, and Apple TV, all hold good promise. They ought to greatly enhance the company’s ecosystem (yet another reason for Android users to switch to an iPhone) in the years to come. Moreover, the new service lines will probably lift profit margins, offsetting any pressures from declining product ASPs (average selling prices).
Price Erosion: One of the amazing things about Apple has been its ability to maintain high ASPs for its products in the face of some pretty formidable competition from Samsung and others in the electronics industry. The company’s pricing power may eventually wane, however, particularly as the tech giant looks to grab a greater piece of the mass cellphone market. This would likely put a dent in the gross margin and contribute to a longer-term deceleration in earnings growth.
Hackers: The security of Apple’s products is critically important to its long-term success. In fact, a reputation for being less vulnerable to hackers and viruses has always been a big selling point for Macs versus PCs. Thus, any security breaches to the company’s platforms could render the demand backdrop more challenging. This is one reason, we think, why the company and CEO Tim Cook put up such a fight in their encryption battle with the Justice Department. Had Apple agreed to create a backdoor to its iPhone encryption process for law enforcement officials, as many had called for, the security of all of its devices, and of its customers’ private data, may have been put in jeopardy. And this almost assuredly would have been bad news for business over time.
All in all, in spite of the recent iPhone deceleration and likelihood that earnings will take a modest dip this fiscal year, we believe that Apple’s strengths and opportunities handily outweigh its weaknesses and threats at this juncture. The rock-solid finances and attractive valuation make this Dow member an even more compelling selection, too. As such, we encourage investors to take a close look here. It’s not often that a company of this caliber goes on sale.