Apple's iPhone 16 Launch: Business as Usual or a Game-Changer?

Apple: The Pre-Order Data Will Tell Us The Truth Soon (NASDAQ:AAPL)

I initiated coverage of Apple Inc. (NASDAQ:AAPL) (NEOE:AAPL:CA) stock in December 2021 and gave the stock a 'Hold' rating, pointing to the strength of the brand but also a fairly generous valuation at the time. A few articles later, on April 10, 2023, I downgraded AAPL stock to "Sell", and since then, I kept my rating unchanged. Unfortunately, pricey stocks may stay pricey way longer than we can predict, so despite the stagnation of the business, AAPL stock beat the S&P 500 Index (SPX) (SP500) by 317 b.p. (36.91% vs. 33.74%) since I downgraded it. In my latest bearish call, I noted that AAPL stock abruptly broke its medium-term sideways consolidation channel after investors and analysts cheered the company's AI-centric plans unveiled at the WWDC developer conference on Monday. Since then, the AAPL stock price has been in a short-term consolidation, and even the recently introduced 16th generation of iPhones has not had a significant impact on the stock's performance. Today, I've decided to upgrade my rating to "Hold" and no longer try to fight the irrationality that has appeared in AAPL's price action in recent months and even years. I still think Apple is a highly overvalued stock, but I definitely like the introduction of Apple Intelligence. The company reported revenue of $85.8 billion for Q3 FY2024, which not only marked a 5% YoY increase, but it was enough to exceed the consensus forecast of $84.4 billion. This was particularly noteworthy given that the whole growth occurred during Apple's seasonally weakest quarter. Thanks to its operating leverage, AAPL was able to deliver GAAP earnings per share of $1.4, up 11% YoY, also beating the consensus estimate of $1.34 (although there was a sequential decline of around $0.13). The double-beat results and no significant negative guidance changes led to Q4 earnings revisions en masse: I think what we saw in Q3 again was that Apple's geographic expansion strategy is indeed proving effective, as evidenced by record revenues in over two dozen countries, including major end-markets like Canada, Mexico, Germany, and the U.K., as well as growth economies such as Indonesia, the Philippines, and Thailand. It was these markets that helped offset the decline in sales in China (-7% YoY), which was anticipated due to "economic and competitive pressures." Apple's sales went up in the Americas region (a 7% YoY increase), and in Europe (an 8% YoY rise), so the firm kept capitalizing on diverse market opportunities. The company's services segment, which achieved an all-time record revenue of ~$24.2 billion, up 14% YoY, further diversifying away from the hardware cyclicality dependence, which is, of course, good news for investors. Despite a slight decline in market share to 15.8% from 16.6% a year earlier, Apple continues to lead in smartphone revenue and profit share globally. The iPhone generated $39.3 billion in revenue, accounting for 46% of total sales, with a slight YoY decline of <1%. Additionally, the growth in Mac sales, with revenue of $7.00 billion (+3% YoY), and iPad sales (+24% YoY growth to $7.2 billion), indicates Apple's strength in the computing segment, in my opinion. However, financials for Q3 are a thing of the past. In any case, they quickly faded into the background as Apple held its annual presentation of new products, where the main focus was, as always, on the iPhones. While there were no major surprises, the event provided important details about the rollout of Apple Intelligence, iPhone pricing, and the new Visual Intelligence feature. The announcement that Apple plans to introduce Apple Intelligence to ~40% of the iPhone installed base by the end of this year, and >70% by the end of next year, aligns with the initial market's expectations and suggests a slightly accelerated rollout, Morgan Stanley analysts noted in their recent research report (proprietary source, September 2024). They add that the "70% installed base" could potentially drive upgrades sooner than anticipated, as consumers may choose to "future-proof" their devices in anticipation of these new features. The iOS 18 promised to make iPhones more personal and intelligent, which could drive future sales - at first glance at least, that's true. The Apple Intelligence suite of tools should focus on 4 use cases: In a survey by US AlphaWise Survey (part of Morgan Stanley, proprietary source), ~60% of iPhone owners planning to upgrade in the next 12 months said Apple Intelligence was important to their decision. The analysts conclude that this "illustrates the importance of Apple Intelligence to the iPhone 16 upgrade," but I think those who were planning to upgrade their iPhone would have done so anyway, with or without Apple Intelligence features. I believe what really matters now for the market's further reaction to the iPhone 16 is the early pre-order data and the subsequent rollout of Apple Intelligence. Although the company may currently lag behind peers like Alphabet (GOOG), Microsoft (MSFT), and Meta (META) in AI development, its focus on privacy and on-device processing could become a significant differentiator in the long term, Argus Research analysts noted in their August report (proprietary source, August 2024). From a technological innovation perspective, I have a few questions about Apple Intelligence's new features, but I'm concerned about the long-term trend of declining mobile carrier upgrade rates (postpaid upgrade rates) that we have been seeing for several years now. This data tells me that people are keeping their devices longer: either for economic reasons, satisfaction with current technology, or lack of compelling new features in the latest models, but the trend itself is not healthy for Apple. The chart above suggests that Apple's seasonal sales figures should improve soon, but it's by no means clear that Apple Intelligence will be a sufficient argument for consumers to rush to upgrade their devices. We're going to see soon. Now, a few words about Apple's valuation. The company's capital return strategy, including a large share buyback authorization of $110 billion and a systematic dividend increase (recently by 4% to $0.25 per share), is helping to create shareholder value and a valuation premium. In my opinion, however, the multiple expansion has gone too far. We don't know exactly what P/E multiple is appropriate for AAPL, but the company has been generating positive cash flow for many years, so we can try to value it using DCF. I know that many are skeptical about the DCF method, but in my opinion, no better method has been invented yet. I will deliberately take the consensus proposed today as a basis, even if I consider the forecast EPS growth rate of almost 25% in FY2026 to be too optimistic - and this forecast is based on only one opinion, according to Seeking Alpha Premium data. Be that as it may, I added a generous premium to each forecast year sales figure and left the forecast EBIT margin above 32% for the period 2026-2028. I also left other driving assumptions on their default mode, which reflects long-term averages. Here's what I get for my operations model: Assuming a cost of debt of 4% (with a risk-free rate of 3.5%, so the spread is minimal in this case), I also assume an MRP of 5%, as I normally do when valuing any business. As a result, I get a WACC of 9.5%, which seems to me to be an appropriate discount rate under today's conditions. AAPL is currently trading at an EV/FCF of about 32.45x, which is more than 65% above its 10-year average. I expect this multiple to fall to 30x at least by the end of FY2028, kind of mean-reverting. Taking all these factors into account, I arrive at a fair value of AAPL stock, which limits its intrinsic growth potential in light of all my optimistic assumptions. As Morningstar analyst William Kerwin recently noted (proprietary source), Apple is a differentiated consumer technology provider with tight integration between its hardware and software driving a wide economic moat. Indeed, I can't argue with this statement. I like how management has adeptly addressed weaknesses in certain regions, such as China, by leveraging strengths in other regions, like the Americas and Europe. Additionally, the increasing share of services revenue is noteworthy, as it's likely to continue growing and reducing reliance on hardware sales. This shift is beneficial in terms of gaining at least partial independence from market cyclicality. The recently unveiled new Apple Intelligence features have created a wave of interest among investors and users, but it's not yet clear how this will affect upgrades and prospective sales figures. We will have to wait for the pre-order data (lead time) to tell what extent this will be a game-changer for AAPL. But the stagnant momentum in postpaid upgrade rates looks kind of scary. Today's DCF valuation model of mine suggests that even if we add a meaningful premium to Apple's consensus revenue figures and margins, the stock would turn out to be at best fairly valued. The lack of a strong overvaluation prevents me from confirming my previous "Sell" rating this time, but I also see no reason to raise the rating to "Buy".

Apple Introduces iPhone 16, It's Business As Usual (AAPL)

Given the current valuation and market conditions, I reiterate a "Hold" rating on Apple. We are back with another Apple (NASDAQ:AAPL) event. This was great timing for this follow-up article that I wanted to publish anyway, as I aim to publish follow-up coverages every quarter. It is getting more and more difficult to be surprised at these events. My reactions to supposedly big announcements have been limited, and this is what I have observed from people around me. I acknowledge the fact that the loyal customer base might get more excited, but this article will evaluate these announcements from a perspective that incorporates the future of the business and the stock price. While Apple already has a significant competitive advantage in the mobile phone space, I am unsure if it will be able to turn AI (artificial intelligence or Apple Intelligence; however, you like to read this) into an advantage over its peers. The new features, the Apple ecosystem has, are easily replicable by its competitors. Therefore, I struggle to see a "replacement cycle" as some people are suggesting. With that in mind, and concluding that the stock price is fairly valued, I reiterate my "Hold" rating on Apple. I think there are better opportunities in the market. This description will be even shorter than last time. People are aware of what Apple does and how it earns money. However, I would like to highlight a couple of interesting details. iPhone sales made up more than half of Apple's total revenue in 2023. That's why these big events where they introduce newer models are crucial for the business. 26% of revenue was from other products including Mac, iPad, wearables, and home and accessories, while the remaining 22% was services including Apple Store, Apple TV, Apple Pay, and more. This is where I want to remind readers that Apple has been transitioning from a product-focused company to a services-focused one. The services mentioned above are significantly more profitable. To be exact, the gross margin on services was 74% in Q3 2024 LTM, compared to 37% for products in the same period. This transition makes the company more profitable overall and may even extend its lifetime as it diversifies its offerings. However, it's not only the gross margin we need to look at. As the business grew, Apple started producing significantly more products than it sells. Although it has an immense cash position, this was a poor capital allocation decision by the company, leading to a significant decline in inventory turnover and ROA. This cash could have been used better if it had been directly distributed to shareholders. Naturally, the market changes and Apple has a lot more competitors now than it did back in the early 2000s. Although the company kept its margins high due to a strong brand image, that may have led to a decline in inventory turnover. The company's investments in AI have the potential to reverse this trend if it leads to higher sales and a better replacement cycle, as people have been discussing. However, it is uncertain whether this is happening. Apple's September event was highly anticipated after the WWDC 2024. The company introduced many new features for the new Apple Watch and AirPods, including the hearing health capabilities of AirPods Pro, turning the product into a "clinical-grade hearing aid". While the Apple Watch and AirPods had some nice updates, I want to focus on the iPhone, as it is by far Apple's largest product. iPhone 16 and iPhone 16 Plus will be available on September 20, with pre-orders beginning on September 13. So, we'll see how strong the demand is just in two days from the time of this article. Apart from the aesthetic updates, which have become traditional, the phone comes with a slightly improved battery life, a new Camera Control button, new lenses, and more importantly, "Apple Intelligence at its core". I didn't notice anything significantly new with Apple Intelligence compared to what the company already announced at the WWDC 2024. It includes smart writing tools, text-to-emoji capabilities, and the ability to use your entire Apple identity to answer personal questions. Visual intelligence seems a bit more advanced. To summarize, it is a great-looking phone with good features that people might want to use in their daily lives, like every other iPhone ever introduced... That is why Wall Street's reaction to it was also "largely as expected". Don't get me wrong, I do believe these are great products. However, we need something extraordinary that would push up earnings beyond the expected levels to get excited. Some argue that Apple Intelligence is that extraordinary development, which we will discuss in the next section. In my last Apple article, I touched on the issue of monetizing artificial intelligence. Many companies investing in AI and introducing new features are struggling to monetize it separately. These new features are mostly included in what the company has already been offering to customers. Although companies claim AI will increase the demand for their offerings, that remains a tough bet. Apple Intelligence is integrated into IOS 18. Any Apple device with this operating system has access to it. Although new products are more expensive, the price premium is similar to what the company typically charges when introducing new products. It doesn't seem to have a premium specifically for the AI tools it includes. The starting price for iPhone 16 will be $799. This means that Apple counts on acquiring new customers and the replacement cycle, which is Apple users replacing their old phones with iPhone 16 to be able to use new features. I believe the new features are great, but I also believe they are easily replicable by Apple's competitors. These features will no longer be unique within a year, maybe even in 6 months. AI features have become a requirement to maintain sales, but not a way to increase earnings significantly more than historical growth rates. AI is the new normal. That is why I am skeptical that iPhone 16 will lead to a strong replacement cycle. With price points not leading to significantly higher margins, I believe earnings will not be as high as the expectations implied by the stock price. The following DCF model follows the same assumptions as the one in my previous article. Please refer to that for a more detailed explanation of my calculation methods. Although I may be painting a negative picture with my growth analysis above, I still think Apple is one of the highest-quality companies that will keep growing at a steady rate. It has a loyal user base and can pass on increased costs to its customers easily. That's why I expect revenue to keep increasing strongly. In addition to the revenue growth assumptions, I assume the company will be able to maintain its margins. Using these assumptions, I find an equity value of $3.16 trillion, which translates to a target share price of $206. This presents a 6.5% downside scenario over the current share price at the time of this article's writing, suggesting that the stock is fairly priced. Apple is a company I would like to own if it was inexpensive. I don't believe that the company will see sustainable higher growth rates compared to its history. However, even without that excess growth, Apple is an incredibly high-quality company. I think it will keep growing. However, I think the stock is fairly valued, and there are more catalysts for the downside than for the upside. The venture into AI was necessary to maintain its competitive advantage, but it will not necessarily increase earnings more than the historical growth average, which is what the market has been betting on. Like many other companies, Apple is likely to struggle to monetize its AI offerings. After an "okay" event, Apple stock remains fairly priced. That is why I reiterate my "Hold" rating. I think the market presents better opportunities for equity investors.