Fiscal 4Q 2018 Final Estimates [UPDATED 10/19]

[This was originally posted on 9/10. Please see 10/19 update details below. As of today's (10/19) market close of $219.31, AAPL is trading at a 15.0x multiple on my next-twelve-months EPS estimate (13.9x when excluding next-12-months net cash and dividend).]


Posting a month early and before Wednesday's event, as promised, in order to test my assumptions and intuition into this cycle, as I did last year as well with satisfying results.

The most uncertain item for me this time is iPhone pricing. I'm modeling a modest reduction from last year prices. Hope Apple can achieve this, as it would allow for a more sustainable boost to unit growth over mid single digits and easily beating the record 231.5m units sold in 2015.

The other sources of uncertainty are the Mac and iPad product lines. I'm assuming a significant update (finally) to both lines, announced and available for purchase this week. My Mac projections may be optimistic but the effect on total revenue and earnings of any mistake on my part will be limited.

I expect a strong Apple Watch Series 4 update, helping with continued very strong Other Products revenue growth.

Finally, I've slightly pared back my buyback intensity estimates, and accelerated the gradual valuation expansion mentioned last quarter from 0.1 to 0.25 quarterly increases in the EPS multiple, which now goes to 15x by 2022. Of course, this more realistic valuation reduces the number of shares Apple will be able to retire, resulting in a moderation of FY19 EPS growth from 30% to 23%. However, this is still well above Wall Street analysts, who continue to underestimate the effect of buybacks given their 15% EPS growth estimates when compared to their 5% revenue growth for next year (I'm at 6% revenue growth).


Detailed estimates:

3mo ending Sep18  Rev$B   GM%  $EPS
----------------  -----  ----  ----
Analysts consens   61.2     -  2.76
Apple guide low    60.0  38.0  2.67*
Apple guide high   62.0  38.5  2.84*
My estimates       62.0  38.4  2.83 (4.83b shares)

Fiscal 3Q 2018 Final Estimates

As of Friday's market close of $191.33, AAPL is trading at a 13.4x multiple on my next-twelve-months EPS estimate (12.2x when excluding next-12-months net cash and dividend).

Huge buyback program as predicted. Although didn't specify an extended timeframe, the $110.4b ($10.4b left in previous program and $100b for new program) authorized until next March nearly matched my $115b estimate over the first year. On the other hand, contrary to my hopes for some persuasive punditry dismissal of it all as mere financial engineering and a waste of cash, it seems market participants will just not let Apple steal their shares—unfortunately this means buybacks will retire fewer shares.

This is the fifth consecutive quarter since the very first time ever that the average quarterly stock price started aligning with my one-year targets at this time last year, and since then the valuation has held steady at about 11x forward EPS plus net cash and dividends. So yes, I've been a bit too skeptic for the last year or so, at first understandably skeptic of tax reform passing as promised—which it didn't—and on time, and later about euphoric market sentiment continuing for as long as it has.

So, I'm going to capitulate just a bit (now watch the market turn just as I give up). I've decided to gradually shift my valuation formula to use a multiple of 11x. It's not that I worry that my targets aligning with the current average stock prices makes me look bad or bearish (I'm neither). The year-long deviation is perfectly within the expected variance embedded within such a simple valuation heuristic. Normally I would at least hold on to it for another year or so before revising the parameters that fit the pricing data so well for the last 10-15 years.

But this time there's a wrinkle to deal with when deriving a forecast price for the shares, which is one can no longer attribute all of the deviation to market sentiment even if the fundamentals were correct. Up until now I was able to say, for example, look I guessed EPS and net cash right but the market is valuing that slightly higher or lower than at 10x. But now, because of the huge buybacks, the eventual price path taken has a significant effect on future EPS, so I need to try to be as realistic as possible in the projected price path if I want to claim my projected EPS is not a significant source of error.

Since my FV projection at 10x would remain well below the market price for several quarters, modeling buybacks on that path would retire more shares, which artificially (as it's clear that won't be the real price paid in the immediate term) boosts EPS growth in the future, and saves on dividends, allowing for a little bit more cash to get used on more buybacks further in the future. The market has shown to be not so dumb and apparently won't allow for a bargain, at least for now. That means those compounding effects mentioned will not be as intense in reality as on an artificially low modeled price path—a path which artificially creeps into the future valuation. In reality it now seems pretty evident that neither the market nor Warren Buffett nor Apple will let such a low price path last for even a couple of weeks—much less several quarters—before acting opportunistically to take advantage of any weakness, and thus swiftly eliminating any blatant pricing opportunity for others. To reiterate, this shift to 11x is just my way of trying to reflect the effect of buybacks on EPS more realistically, and not motivated by market sentiment, impatience, or FOMO.

Anyway, I'll do the shift to 11x gradually, over 10 quarters (0.1 quarterly increments), starting with last quarter's trailing value at 10.1x. This means my fair value is now based on a 10.5x multiple and my target is on a 10.9x multiple. For now I'll stop at the following quarter at 11x which will be the target for the next report. I'm willing to continue increasing it—over time—perhaps up to 12.5x or so as long as the market continues to price in the buybacks in advance, as it has so far.

Despite investors holding steady and—as mentioned—pricing buybacks in advance, at least by a year or possibly two, WS analysts are a different animal. Consensus EPS estimates for the next several quarters currently appear to significantly underestimate the effect of buybacks. I see about 15% upside to FY20 EPS expectations due to buybacks alone (my revenue estimates being only slightly higher). Unless analysts are factoring margin declines and/or increasing operating expenses as a percent of revenues, they will have to raise their EPS estimates as Apple continues to brazenly retire well over a hundred million shares each quarter without much regard for the price.

Fundamentals continue to track as expected, not much to say other than slight iPhone ASP uncertainty for next cycle and beyond, offset by more validation of solid Services and Other Products growth. MBP upgrade helps support healthy current quarter guidance from pent up demand pushing for an all-time-high quarterly record for Mac revenue, and a broad Fall lineup update allows for continuing growth next FY. Beyond FY19, capital return program effect on EPS more than compensates for tougher net income compares due to tax reform boost ending this December.

For the next report I'll try to repeat last year's experiment of posting a month early, forcing myself to trust in my intuition well before all the new product features and pricing and reviews and customer reception are known, so stay tuned early in September.


Detailed estimates:

3mo ending Jun18  Rev$B   GM%  $EPS
----------------  -----  ----  ----
Analysts consens   52.3     -  2.18
Apple guide low    51.5  38.0  2.14*
Apple guide high   53.5  38.5  2.30*
My estimates       52.9  38.4  2.25 (4.91b shares)

Fiscal 2Q 2018 Final Estimates

As of Thursday's market close of $167.78, AAPL is trading at a 12.3x multiple on my next-twelve-months EPS estimate (10.8x when excluding next-12m net cash and div).

The key immediate question for this earnings report is the capital return update, in particular the planned level of share repurchase necessary to achieve management's stated goal of reaching zero net cash balance over time. My relatively straightforward model assumes the bulk of free cash flow (FCF) will be dedicated to buybacks, with a smaller allocation reserved for a steady level of M/A activity, dividend payments, and some debt retirement—as it matures or slightly faster.

The base level of buybacks required to maintain a constant net cash balance given the projected FCF generation in my model (net of those reserves mentioned) is in the range of $50–55 billion per year. On top of that, in order to deplete the current net cash balance of $163b, at least an additional $150b would have to be spent in buybacks—barring some huge acquisition which I would consider tragically wasteful. Management's statements of doing this “over time” suggests a tender offer is not part of the plan, so to move this mountain of additional repurchases would take several years, at least 3 and likely half a decade. On the other hand, front-loading the spending on buybacks (within what's reasonable and allowed by SEC regulations) optimizes the number of shares retired given that I project an increasing share price, perhaps after a plateau this year. In short, I'm expecting an authorization to a total $500 billion in repurchases since the end of 2012—an increase of nearly $300b (including roughly $115b, $95b, and $75b spent during CY18-20 respectively)—and an additional 2 year extension up to March 2021. I expect further extensions and more modest increases to the program at this time each year.

As for the quarterly dividends, I expect an increase of 14% from $0.63 to $0.72 per share this year followed by similar increases for the next couple of years, which keeps a fairly constant pace for the total amount spent per year, and then possibly 20% annual increases over the following couple of years to get the yield back above 2%, representing only $2b increases each year in the total amount spent (currently $13b) thanks to the near completion of the extraordinary repurchase activity having achieved its intended effect on the number of shares outstanding. After that, the per share dividend would increase at the same rate that FCF grows, boosted by the compounding effect of the recurring repurchases at over $50b per year.

Not much has changed in my model about the fundamental business drivers. Of course, market participants are now scrambling to rationalize, atone for, or assign blame on last year's collective super-cycle delusions—which fortunately was never a significant driver in my model. The main changes I've made since last year are higher iPhone ASPs and slightly slower unit growth for this year, partly reversing it for the following cycles with not much consequence in the long term. In my opinion, the confirmation of steady, moderate progress rather than fleeting flashes of hyper growth followed by stagnation or declines is a positive development, as this non-hit-driven path is a much preferable approach to predictable and sustainable growth for Apple and its long-term shareholders.

Remember, all of the previously discussed potential boost from capital return will, without a doubt, get dismissed by many pundits and naysayers as financial engineering solely for the purpose of artificially supporting the stock for the benefit of management compensation (because they instead much prefer to see Apple bail out Tesla and Netflix so those dreamy businesses can be funded with zero financial risk, and be able to later say, in case those fail, that Apple crippled them). And the unstated but implied premise is absolutely correct: without a fundamentally-driven growth outcome, all of those billions spent on buybacks are nothing but a gigantic waste of the cash. The only way it can have a positive effect is if the stock price eventually rises meaningfully above the price paid (as has been the case for the $176b worth of past buybacks at an average cost of $102 per share). It requires sustainable upside sometime in the future preferably driven by fundamentals, or—perhaps less convincingly—by reversing the current market inefficiency.

This perennial market skepticism is precisely why I will not yet consider a more sensible valuation multiple for Apple's enterprise value much higher than 10 times earnings. I remain convinced it will take years of solid performance, and coherent, opportunistic and deliberate actions by management before the market allows the value of those decisions to get fully priced into the stock at a market-comparable multiple. Given my current price target and longer term projection (see chart below), it seems likely that the payoff from these next repurchases will be delayed for at least a couple of years. This is no problem—in fact it'd be the best scenario—since the full program will take a few years to execute, and getting an immediate reaction on the stock toward a market-comparable multiple before all that investment gets deployed would work against its potential return.

In this light, all the annoying handwringing about “the super-cycle's bust” and inane claims of “weak iPhone X” are actually a blessing. It really makes no big difference to Apple's business performance—other than for fiduciary duties—what happens to all that extra unneeded cash or what kind of return it can get out of it, nor does Apple depend on its stock price to fund its operations—as opposed to some other darling companies. Apple will keep all the cash it needs to smoothly run the business, will keep on investing a healthy amount to continue to innovate and grow, and will return the excess to shareholders. And it'll do that the most efficient way—through buybacks. But to us long-term shareholders it does matter a great deal where the stock goes and what it costs us, as it is our money and investment. And to make the best of it, we'd love a dirt-cheap stock for the next couple of years.

So, I say thank you, pundits and naysayers, for doing our bidding during the next few years (after that I'll promptly go back to despising your deceitful, manipulative ways). With your doggedly dour doomsaying you're helping Apple help us greedy AAPL holders get the best return we can on our investment.


Detailed estimates:

3mo ending Mar-2018  Rev($M)  GM(%)  EPS($)
-------------------  -------  -----  ------
Analysts consensus    61,193      -   2.70
Apple guide low       60,000   38.0   2.61*
Apple guide high      62,000   38.5   2.77*
My estimates          61,702   38.6   2.79 (5.05b shares)


3mo ending Jun-2018  Rev($M)  GM(%)   EPS($)
-------------------  -------  -----   ------
Analysts consensus    52,310      -    2.19
Apple guide low (e)   51,000   38.0    2.17*
Apple guide high(e)   53,000   38.5    2.34*
My estimates          53,155   38.5    2.36 (4.88b shares)

*EPS guidance ranges derived from other figures provided
 by Apple and diluted shares outstanding estimated by me

Fiscal 1Q 2018 Final Estimates

As of yesterday's market close of $174.22, AAPL is trading at a 14.1x multiple on my next-twelve-months EPS estimate (11.7x when excluding next-12m net cash and div).

On tax reform effects, Apple seems to have provisioned past foreign taxes very presciently as the $38b it announced will pay (presumed over 5 years though regulations allow it over 8 years) is very much in line with the foreign tax deferred liability they would have as of December (was $36b as of September). On the going-forward effective rate, I'm modeling a gradual decline from 22% (current quarter) to about 20% in a year, but I can see it going down to 18% depending on many particularly complex details of the new tax treatment for foreign income.

As for what to do with all the freed-up cash, other than increased R&D and capital spending (mostly already in my model) I'm going with a dividend per share increase of 16% next April and about 20% per year for the following 3 years (raised it 10.5% last year) essentially doubling the current per share amount by 2021 and achieving a 2% yield on my stock price projection. In addition, I model a $110b increase ($35b base annual increase and $75b due to tax reform) to the share repurchase program to a total of $320b through March 2020 (was $210b through March 2019). Assuming my stock price forecast isn't too far off from reality, this would reduce the shares outstanding after the next 3 years to about 4.3b shares, and would limit the incremental total dividend cost to Apple to only about $5b over 3 years (ttm cost is $12.8b).

On iPhone cycle and all the other products business, seems my experiment last September of taking a shot at it well before it all went down was rather succesful, as my guesses were pretty good, particularly guidance. So no major changes to the fundamental business basis for the model other than another bump to ASPs. Be prepared to see many pundits dismissing all of 2018 positives as mere financial engineering, and an intensification of the already schizophrenic negativity for the next cycle.


Detailed estimates:

3mo ending Dec-2017  Rev($M)  GM(%)  EPS($)
-------------------  -------  -----  ------
Analysts consensus    86,750      -   3.80
Apple guide low       84,000   38.0   3.61*
Apple guide high      87,000   38.5   3.82*
My estimates          87,358   38.8   3.98 (5.14b shares)