Long term winner but iPhone deceleration creates headwinds, move to Neutral
Deceleration in iPhones creates near term headwinds
We downgrade shares of Apple Inc. (ticker: AAPL) to Neutral from Buy with a PO of $130.
Although the long term opportunity is significant, we expect near term pressure on shares
driven by (1) significant slowdown in revenue growth as iPhone growth decelerates and other
initiatives like Apple Watch, Apple Pay, Apple Music take time to ramp, (2) China now
accounts for ~25% of iPhone sales (C2Q) and share gains will be more difficult to come by,
(3) the stock price is correlated to gross profit dollar growth (Figure 6), which despite the
mix benefit of the iPhone will decelerate significantly over the next few quarters, (4) the
magnitude of the beats is diminishing creating higher risk to negative revisions particularly
as the Apple watch expectations are likely too elevated in 2016 , (5) the iPhone 6S/6S+ are
likely to be an incremental upgrade (force touch), but not likely compelling enough for driving
a significant change in the pace of share gains, and (6) we do not see incremental capital
return announcements beyond the already announced plans in the near term.
What about new products – Watch, Apple Pay, Music?
We model $0.30 EPS impact from Apple Watch in C2016 and $0.11 from Apple Pay. At its
current ~10mn subscribers for Apple Music (not yet paying), the contribution will remain
relatively small in C2016 at less than $0.10/share. Although the potential exists for each of
these to become significant revenue drivers in the long-run, the short-to-medium term
direction of the stock remains dependent on the iPhone.
Valuation always compelling; Momentum trumps near term
We do not dispute that valuation metrics remain compelling for Apple; however, in the last
down-cycle despite compelling valuation the stock retraced 30%. AAPL stock has rallied
40% in C14 (vs. S15INFT up 18%), and is trading at multiples at a slight discount to peers.
Where could we be wrong? PO moves to $130
Stronger than expected share gains of iPhones from Android, or increased enterprise
penetration could drive upside relative to our model. Reacceleration in iPad sales could
offset some of the iPhone decline, but with lower margins. Our new PO of $130 is based on
13x C2016 EPS of $9.99.