Monday, July 16, 2018

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)