BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Apple Stock Still A Bargain If These Three Things Fall In Place

Following
This article is more than 7 years old.

In the midst of a difficult environment for smartphones, Apple reported an upbeat set of earnings and guidance for the third quarter of fiscal year 2016 after the closing bell of yesterday’s trading session.  The stock vaulted about 7% at the start of trading today as the iPhone maker posted better than expected top and bottom line results for the three-month period ended June 30.

Apple reported per share earnings of $1.42 on revenues of $42.4 billion, down from an EPS of $1.85 on revenues of $49.6 billion in the same quarter last year. Due to the saturated macro environment in the smartphone market, Wall Street already had a subdued outlook. Analysts had expected Apple to post EPS of $1.38 on revenues of $42.05 billion, according estimates compiled by Bloomberg.

iPhone Sales

iPhone sales barely edged past consensus for the quarter, driven by the new cheaper SE version. At the earnings call, CEO Tim Cook pointed out that Apple’s iPhone SE gamble had paid off, despite a worrying response from analysts on Wall Street. Mr. Cook insisted that adding SE to Apple’s mix, not only appeals to people who want a 4-inch iPhone but also reaches out to a larger population due to its affordability.

While emphasizing that both these strategies are gaining traction, Mr. Cook went on to say at the earnings call, “At its launch, we said the addition of the iPhone SE to the iPhone lineup placed us in a better position to meet the needs of customers who love a 4-inch phone, and to attract even more customers to our ecosystem.”

The iPhone SE was launched in March for as low as $399 for a 16GB model in US markets. While this struck most people as an oddity from Apple’s usual high-end behavior, the company has been showered with skeptic comments about how ‘Services’ and other streams of revenue are overly dependent on the demand for iPhones.

While separating its services and other merchandise from the iPhone might be a troublesome task, the folks at Cupertino are supposedly trying to land an iPhone in every hand. For now this appears difficult as the cut-throat competition from Chinese OEMs is only adding to Apple’s problems.

Some however argue that a stronger performance from Apple in China and India could have been the company’s saving grace in these times of saturation. The popular notion is that Apple is bleeding market share in China to OEMs such as Huawei and many others. However, China Mobile noted that Apple’s business in the country is much stronger than what the results might reflect.

China Turnaround

While Apple’s China problem still persists amid political turmoil and competition, it’s more than just another opportunity. China is the epicenter of consumer spending growth, and a comeback in the region is essential for a sustainable turnaround.

In the earnings conference call Mr. Cook said, "During the past quarter, I visited China and India,” further stating that “I am very encouraged about the growth prospects in those countries. We remain very optimistic about the long-term opportunities in greater China."

While Mr. Cook’s enthusiasm over Apple’s prospects in China is warranted, the results implicate a completely different picture. Adding to the company’s concerns in China, protesters in the country were recently seen wearing scarves with anti-American slogans and smashing iPhones in front of Apple stores.

Even though the processions were in response to the belief that Washington fueled Manila’s decision to challenge Beijing’s claim on undisputed territory in the South China Sea, such behavior by Apple users in the country does not come off well before the launch of the iPhone 7. Coupled with these factors, stringent rules imposed by Chinese regulators are making it difficult to achieve the desired goals.

Valuation Rebalance

According to Apple, sales growth in the services segment hit 19% in the latest quarter due to a record breaking performance from the company’s app store network. This shows that the ecosystem is still growing briskly. Apple said more than a billion of its devices are actively in use by consumers around the globe. “It’s becoming a very meaningful portion of what we do,” said CFO Luca Maestri.

Apple has a world class ecosystem at its disposal, which the company has so far not yet taken to its full potential. Apple Pay is not fully optimized and Apple TV is basically just a large collection of apps stuffed into one place.

As the world’s most valuable company, Apple undoubtedly has the resources to sort these problems out. As I see it, the iPhone maker only has two ways to go about a turnaround of sentiment. Either strip away from a mono-platform approach or put an apple product in every home.

Apple appears to be doing that with the SE, which has caused the Average Selling Price (ASP) for the iPhone to falter by a considerable margin. This time around, iPhone ASP came in at $595, below the expected $606. This has many analysts fretting over margins - and rightly so - because Apple has always been positioned as a premium brand. A broader change in the iPhone lineup could have some unintended consequence in terms of brand sentiment.

At the same time, several observers welcomed last night’s earnings result which seemed to indicate a return of stability at Apple. Raymond James upgraded the stock to Outperform from Market Perform this morning. Analysts at the firm expect a gradual re-rating of the shares in the coming months, as the company claws its way back to normality, given the current subdued outlook for Apple on Wall Street.

An interesting point raised by analysts at UBS referred to Nassem Taleb’s theory of ‘fragility’ which pointed out that Apple’s stock is too fragile for its liking, given its seemingly discounted valuation. Most analysts agree that Apple is valued largely as a hardware company, despite its reach as a platform and ecosystem provider. Currently, Apple’s forward price-to-earnings ratio (10.8x) falls in the range of slow-growth legacy tech companies such as HP Inc. (8.3x) and IBM (11.4x).

Once Apple achieves a proper footprint as an ecosystem, the UBS analysts reaffirmed my belief that the company’s valuation will shift. Such a scenario would result in a more appropriately valued stock price for the company. Of course, holding on to that belief would make Apple’s current stock price appear a bargain for hopeful investors. Still, the silver lining in the coming months appears to be a bumper iPhone 7 season anticipated later this year. A repeat of 2014’s blockbuster sales records would likely lead any rebalance in Apple’s valuation.

By: Muqeet Khan