Saturday, October 2, 2010

Based On Growth, AAPL Remains Undervalued

At Friday's closing price of $282.52 AAPL is trading at less than 22 times trailing 12-month earnings and at a significant discount to current rates of revenue and earnings growth. Factoring into the mix the roughly $50 in cash supporting each share, Friday's closing price represents a real opportunity for value and growth investors to enter the market and share in AAPL's appreciation potential. 
The Reasons Why AAPL Remains Undervalued
About three weeks ago in a blog post titled FY 2011 Analyst Estimates: Why AAPL Is Set To Pop I highlighted the disparity between analyst FY 2011 estimates for Apple's revenue and earnings performance and the company's current rates of revenue and earnings growth. The disparity remains. Current analyst consensus suggests revenue growth of just over 25% in FY 2011. For the fiscal year ended in late September, Apple will report roughly 50% revenue growth with revenue growth well above that rate in the second half of the fiscal year due to the release of the Apple iPad. I rate the risk of Apple's revenue growth decelerating by 50% in FY 2011 as remote. Analysts will revise their revenue and earnings estimates for FY 2011 following in the couple of weeks before and the weeks following the release of September quarter results on October 18th.
iPhone and Apple iPad Unit Sales Estimates
In reviewing the revenue and earnings estimates for the September quarter now being published by Wall Street analysts and independent bloggers, we are seeing a wide range of estimates for both iPhone and iPad unit sales.  Uncertainty over the strength of unit sales for both product lines may be impacting the current share price. Clarity will come with the release of Apple's September quarter results. 
The June quarter's 3.27 million iPad unit sales performance provides little insight into the September quarter's results due to limited distribution following the April 3rd release and constrained supply conditions that continued through much of the September quarter. The June quarter's iPhone unit sales performance was impacted by an aggressive drawdown of 3GS channel inventory ahead of the iPhone 4's release. In the June quarter iPhone unit sales rose 61% year-over-year versus unit sales growth of 93.7% for the first nine months of FY 2010, inclusive of the June period.
Apple's Growth Rates Delineated
No matter the interest in Apple's September quarter results and focus on the unit sales performance of the company's two fastest-growing product lines, understanding Apple's share price appreciation potential requires a more objective view of the company's current rates of growth as a whole:

FY 2010 revenue growth will be reported at around 50% year-over-year.
FY 2010 earnings per share growth will be reported at 65% or more.

FY 2011 rates of revenue and earnings growth may match the FY 2010 rates of growth due to the lack of prior-year Apple iPad revenue and earnings contributions over the first six months of the fiscal year. 
FY 2010 reported revenue will be at $65 billion or more. Earnings per share for FY 2010  will be at or about $15 per share. 
At Friday's price-earnings multiple of 21.27 times trailing 12-month earnings, an adjustment in share price based solely on the progression of the 12-month historical earning performance would, following the release of the September quarter numbers, yield a share price of almost $320 on $15 in earnings per share.
At 50% revenue growth in FY 2011, Apple will report revenue activity of about $100 billion. To put this rate of revenue growth in perspective, Apple's revenue in this fiscal year will be four times the reported revenue for FY 2007. In other words, Apple will experience a fourfold increase in revenue in four fiscal years.
At an average sales rate of 3 million Apple iPads per month in FY 2011, total revenue from iPad device sales and iPad-related revenue will equal or exceed all of Apple's reported revenue of just under $25 billion in FY 2007. In other words, the Apple iPad alone in FY 2011 may deliver a revenue contribution equal to or greater than Apple's total reported revenue in FY 2007. The Apple iPad may contribute as much as 25% of Apple's reported revenue this fiscal year.
Price-Earnings Multiple Absent The Cash
If one were to remove Apple's hefty cash position of roughly $50 per share from the current valuation, Apple's p/e multiple based on earnings alone falls to about 17.5 times trailing 12-month earnings. Assuming FY 2010 earnings of $15 per share, the multiple, absent the cash, would fall to about 15.5 times trailing 12-month earnings following the release of September quarter results. This valuation is a deep discount to the 65% earnings per share growth rate for FY 2010 and a similar pace of earnings growth expected in FY 2011. Should the market maintain the current price-earnings multiple of 21.27 as a constant, based on 65% growth in earnings per share, Apple's share price would reach well over $500 by November of next year.

 I reiterate my current AAPL price target of $450 per share. Based on the anticipated earnings progression and even with some compression in the p/e multiple over the next year, estimated earnings growth puts my target price within reach. 

Why Apple Will Sustain The Current Rates of Growth In FY 2011
The Apple iPad alone, at a reasonable sales estimate of 3 million units per month, will generate an additional $18 billion or more in iPad and iPad-related revenue in FY 2011. To reach $100 billion in revenue in FY 2011, other operating segments of Apple would need to increase their respective revenue performances by the following percentages due to revenue weighting: 60% growth in iPhone unit sales, 20% growth in Mac unit sales and 20% growth in the Other Music Related Products and Services segment. iPod device revenue would need to essentially hold its own. 

The rates of revenue growth needed to achieve an outcome of $100 billion in FY 2011 are below the rates of growth in FY 2010 for the above-referenced product lines. At a 50% growth in revenue, Apple will sustain 65% growth in earnings per share, yielding an outcome at or above $24. Please see my primer entitled Understanding Apple's Success Made Easy for more insights into my forecasts.
Robert Paul Leitao


  1. It doesn't matter how much potential this stock has, it still is being controlled by the hedge funds and it still drops like any other tech stock on a down market day and sometimes even worse. Due to the nature of this stock, it continues to stay very volatile for a company that can hardly keep up with supplying demand on a global basis. Apple has a whole bunch of recently opened retail stores that stay packed.

    So even though Apple has such high target prices by dozens of analysts, come Monday, if some tiny economic indicator is weak, Apple will lead the market drop. I don't know what's going to make this stock pop over $300. I'm sure it will, but when is anyone's guess.

  2. I have yet to see any studies of the impact that iPad sales will have in the future on iTunes store revenue, but to me it's one thing to sell 7 mil iPads in a quarter but it will be quite another thing when 5 years from now there will be 100 million iPads in use with many buying items from the iTunes store. Eventually iPad hardware sales slow down but iTune sales will experience sales increases a geometric proportions. And, I believe the market should reward this recurring class of income with a much higher multiple.

  3. Anonymous:

    You bring up a good point. I've taken some flak for my optimistic iTunes revenue projections for the September quarter. This revenue segment will grow and should grow impressively over the next several quarters due in part to the release of the Apple iPad and the availability of more sophisticated and higher-priced apps for the device.