Apple’s equity enters bear market territory

The market capitalisation of Apple Inc surpassed USD1 trillion in early August as its share price reached $207.05 becoming the world’s most valuable company. It then edged up to a record of $233.47 on October 3 but has since suffered a remarkable setback as it dropped to an intra-day low of $185.93 on November 14, representing a decline of 20.4 per cent.

Financial market commentators would therefore claim that the equity is in bear market territory since it dropped by more than 20 per cent from its all-time high. A decline of 10 per cent on the other hand is normally referred to as a ‘correction’.

During the broader market sell-off in October referred to as ‘Red October’, Apple’s share price held up relatively well and only eased by three per cent while other technology companies saw their equities decline substantially more such as Amazon (-20 per cent), Netflix (-19.3 per cent) and Alphabet (-9.7 per cent). However, the equity of Apple mainly started to suffer following the publication of its latest financial statements on November 1.

Apple reported better-than-expected results during the fourth quarter of their financial year to September 30, 2018 with revenues of $62.9 billion (against the forecast of $61.5 billion) and profits after tax of $14.1 billion (against the forecast of $13.4 billion). During the 2017/18 financial year which came to an end on September 30, overall revenue amounted to 30 265.6 billion (+15.9 per cent from the previous year) and profits after tax amounted to 30 $59.5 billion (+23.1 per cent over the previous year) giving a return on equity of 49.4 per cent.

However, during the quarter ended September 30, the company sold a lower amount of iPhones (46.9 million vs 47.5 million) and predicted weaker revenue guidance for the following quarter – the Christmas season which is the most important period for the company’s overall financial performance. Apple said that its overall sales revenue during the holiday season, the busiest quarter for the company and the first quarter of its financial year, would range between $89 billion and $93 billion which analysts claimed may fall short of the top-of-the-range figure of $93 billion that had already been predicted by many followers of Apple. Apple’s CFO stated that the guidance for the December quarter suggested a new all-time record for revenue and profits if the company achieves its target.

While the company sold a lower amount of iPhones than originally expected during the September quarter-end, this was compensated by a higher average selling price of $793 against forecasts of $750.93 following the launch of newer models at higher prices. Revenue from sales of iPhones amounted to $37.2 billion during the quarter to September 30 accounting for 59.1 per cent of overall sales.

Other encouraging signs for shareholders was the increase in the operating margin to 25.6 per cent (the first rise following declines in the past 11 quarters) from 24.95 per cent in the comparable quarter last year as well as strong revenue growth in China of 16.4 per cent despite concerns about China’s recent economic slowdown as well as trade-related issues with the US.

On the other hand, however, Apple’s penetration in India (perceived to be the next major economic engine in the future since it is predicted that within four years it is due to exceed China as the world’s most populous country) is still only one per cent with the other Asian mobile phone producers dominating the market due to their lower-priced phones.

Apple reported better-than-expected results during the fourth quarter of their financial year

The main factor that possibly disappointed the investment community and led to the immediate sharp decline in the share price on November 2 was the statement made in the customary ‘earnings call’ following the release of the financial statements that as from the next quarter, Apple will stop declaring the number of units sold of each of its products.

This was viewed as a tactic by Apple to hide a decline in iPhone sales. Many analysts were disappointed at this new reporting procedure since the sales figures for each of the product categories (namely iPhones, iPads and Macs) had been one of the main indicators to gauge the performance of the company from one period to the next.

Apple’s CEO defended this decision by stating that Apple is in effect shifting from a retail company to a service company, consisting of app-store sales, the use of their mobile payments platform Apple Pay, AppleCare and music-streaming subscriptions. The services segment is the second largest revenue generator following the iPhone accounting for just under 16 per cent of overall revenue. Moreover, Apple’s CFO argued that the number of iPhones sold in any given quarter is “not necessarily representative of the underlying strength of our business”.

The strategy of shifting to a services-oriented company aims to capitalise on Apple’s customer loyalty by building what is referred to as an Apple ‘ecosystem’. If Apple continues to maintain a high customer loyalty, the strategy can pay-off by translating into more stable sources of revenue and making Apple less dependent on the success of any new launch of an iPhone model.

However, the decline in the unit sales numbers of iPhones is concerning some commentators since this could translate into a lower use of Apple’s services segment.

In fact, the sharp downturn in Apple’s share price over the past ten days was sparked by lower financial forecasts from some of Apple’s suppliers such as Lumentum Holdings and Japan Display. Both suppliers warned of an expected slowdown in sales. Although both these companies failed to disclose the identity of their customer, many analysts are speculating that it is indeed Apple. The reduction in forecasts by these suppliers is being taken as a clear sign of a declining growth rate in Apple’s iPhone since almost 60 per cent of the company’s revenue comes from the sale of iPhones.

Apple’s share price is trading on a forward price to earnings multiple of circa 15.2 times. Some international financial analysts claim that investors are now becoming very cautious about the company’s future growth potential in competitive and important markets like China and India but the market is underestimating the income-generating potential of the growing services business.

Apart from the growth in the services segment, many analysts are possibly focusing on the growth in profitability also arising from the sizeable share buybacks taking place. Apple significantly accelerated its share buyback in the wake of the tax reform last year and the company still has $122.6 billion to return to shareholders before it reaches its objective of being net cash neutral.

Another major supporter of Apple is the legendary investor Warren Buffett who in recent months had increased his stake in Apple to the largest component of the portfolio within Berkshire Hathaway. Last week, Berkshire disclosed its latest portfolio changes and they currently hold $55 billion worth of Apple shares in their investment portfolio. During the past three months, Warren Buffett’s investment holding company accumulated an additional 500,000 shares of Apple.

Despite some of the warning signals from various quarters, most financial analysts maintain an overall bullish outlook on Apple’s equity. According to Bloomberg, out of the 49 analysts covering Apple, 29 have a buy rating. The average 12-month share price target is $233.59 with the targets ranging from a low of $165 to a high of $310 compared to a current market price of $190.

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