Monday, April 2, 2018

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

12m ending Sep-2018  Rev($M)  EPS($)
-------------------  -------  ------
Analysts consensus   261,874   11.44
My estimates         262,672   11.94

Valuation (fwd-12mo from)  EPS($)   Y/Y  10x  Cash*  Div  Tot
-------------------------  ------  ----  ---  ----  ----  ---
Trailing       (Apr-2017)   10.41   22%  104    30  2.52  138
Fair Value     (Apr-2018)   13.68   31%  137    17  2.88  157
1yr Target     (Apr-2019)   15.87   16%  159     8  3.24  170

* Cash per share balance net of long-term debt
(click to enlarge)
F2Q18 Revenue breakdown: iPhone 38,871 (53.0 × $733) iPad 4,327 ( 9.5 × $455) Mac 6,086 (4.35 × $1,399) Services 8,758 Other 3,659 ( 5.3 × $381 = 2,022 Watch) Income statement: Revenue 61,702 COGS (37,866) GM 23,836 38.6% OpEx (7,629) OpInc 16,207 26.3% OIE 333 Pre-tax 16,541 Tax (2,481) 15.0% NetInc 14,059 22.8% Shares 5,046 EPS $2.79 (amounts in millions except $ASP, $EPS, and ratios%)


Anonymous said...

Thank you! - Roger

Anonymous said...

Ditto, thanks.

As frustrating as your narrative is about the market's perceived value, I agree with it. I may take a look at LEAPS.

Anonymous said...

Thanks Daniel - great commentary and lucid prose. Quoted you at Braeburn Group with link to your piece.