Not So Deep Dive: Apple Stock
(Ryan) What they do: Obviously most people know what Apple does, so I’m going to try and provide a little more value by going through each reporting segment and how much of revenue they make up.
5 reporting segments for Apple in order of size:
iPhone: This makes up 52% of revenue. This is their line of smartphones and maybe the greatest single product ever made. In September, the company released their line of iPhone 13’s (iPhone 13, iPhone 13 Mini, iPhone 13 Pro, and iPhone 13 Pro Max). Each of these runs on Apple’s iOS operating system.
Services: 2nd largest revenue driver, and accounts for 19%. This is comprised of Advertising (search ads in the app store, ads in Apple News, etc), AppleCare (fee based service and support products), Cloud Services (customers can buy additional storage for all their data), Digital Content (this includes app store fees, Apple Music, Apple Arcade, Apple News+, AppleTV+), and lastly Payment Services (Apple Pay and Apple Card)
Wearables, Home, and Accesories: 10%. This segment includes Airpods, the Apple Watch, Apple TV, Beats, Homepod, and the iPod Touch (that still exists?)
Mac: 10%. This is their line of personal computers. Most recent update was in October, and the company came out with a redesigned Macbook Pro. Also have the iMac in this segment.
iPad: 9%. This is their line of tablets and it actually runs on its own iPadOS. The 4 big ones here are the iPad, iPad Air, iPad Pro, and iPad Mini.
Majority of their sales still come from the Americas, but China is the fastest growing geography on a percentage basis. Their hardware for the most part is manufactured in Asia, which is relevant given some of the shipping problems.
(Ryan) History: Many people have probably heard the founding story about Steve Jobs and Steve Wozniak starting Apple in Job’s garage. So I won’t spend too much time there. Jobs and Woz started the company in 1976. They were college dropouts. Jobs was the visionary, Woz the engineer. Woz left in 83 after a bit of a fall out, and Jobs left in 1985. After that he founded NeXt Software and bought Pixar.
But Apple really hit its stride in the 2000’s. So Apple acquired Jobs new company, Next software, and Jobs was eventually promoted to CEO. Shortly after, Apple launched the iBook and the iPod and in 2007, launched the iPhone. Since that point, Apple’s stock has grown more than 42 fold. Unfortunately, Jobs died shortly after in 2011 at which point Tim Cook who had been the COO took over.
Apple operates in the electronic devices and information technology industry. I think people understand the industry Apple operates in but let’s go through them
Smartphone units are projected to be 1.38 billion units worldwide in 2021. iPhone costs $400 - $1000+ so the target market is huge.
Smartwatch industry: 69 million units in 2020, expected to hit 230 million units in 2026. Watches cost $400 - $750
PC and Laptop industry: 80.6 million PC units, 275 million laptops, 160 million tablets. Apple has a much smaller market share here.
Mobile operating system industry: iOS has an estimated 30% market share worldwide. Android has 70%.
Competitors: Samsung, Google (android, hardware, watches), and then many other competitors for the services part of the business.
(Ian) Management and Ownership:
Tim Cook is the current CEO
He succeeded Jobs as CEO in 2011
He started at IBM after graduating from Auburn and worked his way up to become director of North American fulfillment of its new PC division
He then worked at Intelligent Electronics and then at Compaq
Steve Jobs returned to Apple in 1997 and hired Tim Cook as senior vice president of worldwide operations to be part of the “new Apple”
Cook was behind the move to contract manufacturing which allowed Apple to build more faster, developed the relationships that have created competitive advantages over the past number of years. He is known as an operational efficiency mastermind.
When he joined, the stock price was below what it had been in the late 80s and Michael Dell was suggesting that Steve Jobs should just return money to shareholders. Had to be tough to join.
Cook is 61 and the rumor is that he wants to launch one more product category before retiring, probably ar glasses (2025ish)
Insiders own 6bps of Apple stock, but Tim Cook does have about half of his net worth in Apple ($568mm)
The largest holder of Apple stock by far is actually Berkshire Hathaway owning over 5% of shares outstanding
Market cap $2.7 trillion, ticker AAPL
EV of $2.63 trillion (approximately)
EV/s of 7.2
EV/gp of 17.2
EV/OI of 24
EV/FCF of 28
Dividend yield of 0.53%
Share count has consistently gone down since 2014, no worries from dilution on valuation, it actually is a positive for this one
(Ryan) Earnings: Already reported their Q4.
$366B in total net sales, up 33% YoY
iPhone was the fastest growing segment, but all segments grew their top line by more than 20%
Apple’s aggregate gross margin was 42%. Hardware GM of 35.3% and services GM of 70%.
Opex as a % of revenue declined from 14% to 12%, leaving them with $109B in operating profit or 30% OMs
$104B in OCF up 30% YoY. And about $93B in FCF
Fun to look at their retained earnings column, just to see how much Apple is actually returning to shareholders. They paid $14.4B in dividends for the year + $85.5B in repurchases. That’s $100B in capital returned to shareholders on $93B in FCF.
They weren’t specific here, but they expect YoY revenue growth in Q1 but it will be a deceleration from Q4 which was up 29% YoY
Gross margin and Opex will stay consistent, but they said supply constraints will continue to impact revenue. In Q4, they said they lost $6B in revenue from supply constraints.
(Ian) Balance sheet and liquidity:
$190B in cash and marketable securities, the largest bucket is in corporate debt securities (nearly $85B)
Next treasuries, MBS, and Non US-govt securities of about $20B each
From 2020 to 2021 they appear to be getting out of treasuries and into corporate debt
Including about $12B of leases, Apple has debt of ~ $137B
This primarily consists of fixed-rate term notes with interest rates randing from 0-5%, the majority of which is due after 2026
They earn more in interest than they pay.
Share count is steadily declining, down almost 25% since 2016.
Bought back over $90B in stock over the past 12 months (3-4% of shares)
(Ryan) I have the phone, ipad, mac, and watch. I’m not an avid Apple fan, but for the watch phone and ipad it’s nice to stay in the ecosystem.
(Brett) They have a lock on smartphone/Watch for U.S. audience. Everything else is more of a commodity for most people it seems.
(Ian) I never think about buying any other phone, only a different computer if I am looking for a second computer.
Future growth opportunities:
(Ryan) Apple Pay. Since Apple’s pretty discreet about how much its services segment generate, it’s a little difficult to tell if this is a needle mover for them, but anecdotally I’m seeing a ton of adoption among peers. Not only P2P money sent through texts, but I’ve heard more and more friends asking if places accept Apple Pay. And oftentimes they do. 3 years ago, I would have said mobile payments seems like it wouldn’t pick up steam in North America, but I’ve since changed my mind. (Also, if MSFT/ATVI deal doesn’t go through, I think Apple should try to acquire King games and incorporate it into Apple Arcade).
(Brett) I think the Watch still has “a lot of room to run” so to speak. They have executed brilliantly with the product and it is becoming a fashion statement like the iPhone did, which gives it the brand differentiation. Nobody buys Fitbit watches for a reason, even if other ones have better technology or features. Those new ads are something else though.
(Ian) AR Glasses. VR Headset (late 2022, early 2023) and then AR glasses after
Highlights and lowlights:
(Ryan) Highlights: This is such a well run business and it’s incredibly shareholder friendly. The brand loyalty makes new product expansion much easier. Lowlights: App store pressure is probably the biggest one, but there’s no telling exactly where that will go. Also China.
(Brett) Highlights: Buyback program, Watch, and execution with Services has been remarkably strong (outside of Apple Arcade and News). Lowlights: China overhang, reliance on less subscription-y revenue than Microsoft/Google that feels harder to predict, the Google Search deal, Siri, app store fees potentially going away.
(Ian) Highlights: Tim Cook (followed Jobs supremely well, but did not try to be Jobs). Best company in the world??? Transition toward services is good for the business, higher margin and more predictable (70% vs 35% gm). Lowlights: Antitrust and breakup potential, reliance on China
(Ryan) Assuming buybacks + dividends stay consistent (looks like they’ll grow), shareholders are getting nearly a 4% yield today. Add in high mid single digits FCF growth, which I think is achievable, and shareholders should get near a 10% return even at today’s multiple.
(Brett) Watch continues ascent, Services continues ascent, and iPhone/iPad/Mac demand stays stable. Cash flow inches towards $200 billion over the next decade while shrinking share count.
(Ian) AR Glasses, the car, services, metaverse, etc. applications drive consistent growth for Apple going forward and investors benefit from growing revenue and declining share count.
(Ryan) Regulatory pressure drives down app store fees. Services is only 19% of revenue but it accounts for 31% of gross profit. That could hurt. All in all, given the capital being returned to shareholders, I think the floor is pretty high here. Bear case to me feels like low single digit returns over next 5 years.
(Brett) All consumer demand driven (stimulus checks/depletion of savings gave them a bump in demand most likely), so if that sours growth is gone. There are only so many consumer discretionary dollars out there to spend. App store/Services blows up. AR Glasses/Car/other don’t succeed at all.
(Ian) Apple is not able to launch successful new products, growth is non-existent and the market rerates it. Goes from 20x ebitda to 6-8x ebitda.
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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.