Apple is a compelling buy

Apple will rebound once tax related selling ends in January and the new taxes on capital gains are known to the stock market.

Apple’s fall from grace was as swift as it was spectacular. Apple peaked at 705 in September and fell as low as 507 in mid-December. The reasons for Apple’s 200 point fall are not convincing. A fabled analyst at UBS cut its 2013 earnings per share estimate from 51 to 47 expecting slower sales of the iPhone 5 in China. Yet UBS still has a price target of $700 on Apple, down from $780. This is almost 40 per cent higher the stock’s current trading price on Wall Street. Apple’s failure to give its shareholders a special dividend (given its legendary cash hoard) is cited as a reason for selling. I disagree.

Apple is a growth company and special dividends are not the momentum ballast for growth companies. Apple’s shareholders can expect one of the most epic share buyback programmes in the history of Wall Street. Tax uncertainty selling is, of course, a factor in Apple since its shares have proven so profitable for investors since it bottomed in early 2009. Yet this argument only reinforces my conviction that Apple will rebound once tax related selling ends in January and the new taxes on capital gains are known to the stock market.
I concede that Apple has broken significant chart related technical milestones, including its 200 day moving average and the proverbial death cross. To technical analysts on Wall Street, Apple is broken share. However, a broken stock is not a broken company. Apple dominates the global markets for tablets and smartphone with its unique, innovative products. Apple is one of the most undervalued companies in Silicon Valley relative to its growth potential, now that it has fallen 26 per cent since its September high.

Signs of Resilience
Apple’s China opportunity is still in its embryonic stage and its products are considered status symbols/cutting edge in the world’s biggest mobile phone market. China’s mobile market is simply colossal, with 1.09 billion mobile subscribers and market growth rates are as high as 15 per cent. Smartphone penetration rates are a mere 19 per cent in China, a huge opportunity for Apple (and Samsung). Apple’s deal with China Mobile (the biggest carrier in the PRC with 700 subscribers) could be a catalyst for it. Even as blowout revenues and earnings in January vindicate its unique software/services/hardware ecosystem business model, I believe Apple will rise to 600-620 in the next three months. Why?

One, the product launch momentum in Apple will only accelerate as the iPad Mini/4th gen iPad extend Apple’s tablet market penetration on a global scale, as mobile/Wifi versions of the two devices only add to the sizzle. Two, China Mobile will begin selling the iPhone in 2013 even as the iPad Mini is the ultimate PC killer in the Middle Kingdom and emerging markets. China Mobile alone has the potential to sell 80 million smartphones in China.

Three, valuations matter and Apple enterprise value/EBITDA is now a mere six, the cheapest in a decade. This is value that, irrespective of capital markets temper tantrums, makes Apple irresistible to me. After all, Apple traded at an enterprise value/EBITDA of eight last September (the 700 high) and 12 times back in 2010 on the eve of its spectacular new product growth cycle.

Four, the supply chain/shipment delay/component risk of Apple are overblown. There is no reason to expect Apple will not sell 46 – 48 million iPhone 5 units in 4Q 2012, as no global recession is in sight.

Five, the glory days for Apple were 2010 – 11, Apple is still the most innovative consumer tech company on planet with a global addressable market with at least a 20 per cent secular growth rate.

Six, in a world of bankrupt countries and overleveraged state/crony capitalist corporates, Apple has a stellar balance sheet, $125bn in cash (or $128/share) and no long term debt, with the potential to generate $10bn in cash every quarter in 2013. This makes Apple an ideal candidate for long term put LEAP sales to generate premium income, in my opinion. The mathematics of extrapolation can, however, be misleading. After all, an Oxbridge statisticians who examined trends in the biological horse residual carriage traffic in Piccadilly Circus in 1900, the year Queen Victoria died, extrapolated that London would be covered with 70 feet of horse manure by the year 1980? Yet I still extrapolate Apple cash flow at $250 a share in 2015.

Seven, Apple will not announce a special dividend, though the payout ratio may well rise as the free cash flow tsunami builds. I believe the Apple will accelerate its share buyback program, Apple could well buy back $50bn in the next three years. This will be hugely bullish for the shares.

Eight, the short interest/put option on Apple convince me a squeeze is all too possible if Apple beats its whisker number next month. This could mean a $50 – 80 post earnings spike in Apple in January.

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