Apple Equity Research Report Final

8/13/2019 Apple Equity Research Report Final

1/13

Haohan, XuJOHNS HOPKINS UNIVERSITY-CAREY BUSINESS SCHOOL 100 International drive, Baltimore, MD, 21202

EQUITY RESEARCH REPORT ON

APPLE INC


2/13

Page 1of 12

Summary of Investment Thesis

Sector: Global IT Hardware, Overweight

Price target: $759

Current Share price: $521 on 02/07/2014

Ticker: AAPL-NYSEOutperform (Buy)

Apple Inc. designs, manufactures, and markets personal computers and related personal

computing and mobile communication devices along with a variety of related software, services,

peripherals and networking solutions. The company sells its products worldwide through its

online stores its retail stores, its direct sales force, third party wholesalers and resellers

(Bloomberg, L.P.).

Source: Bloomberg, L.P.

Company Description

Head-quartered in Cupertino, CA, United States, Apple is one of the most iconic IT hardware

companies. According to the company 10K, Apple had $170.9 billion revenue and $37.0 billion

net income. As of the fiscal year end, 2013/09/28, Apple had $207 billion assets, and $434.1

billion market capitalization. The company manages its business primarily on a geographic basis.

Note that the results of the companys geographic segments do not include results of the retail

segment.


3/13

Page 2of 12


Products

Apple sells various products and services: iPhone is the companys line of smartphones; iPad

and iPad Mini are the companys multi-purpose tablets; Mac is the companys line of desktop

and portable personal computers; iPod is the companys line of portable digital music and

media players; the other categories include iTunes and iTunes store, Mac App Store etc.

(Company 10K)


Industry analysis and Apples competitive positioning

iPhone

53%

iPad

19%

Macint

osh

13%

iTunes/

Software

/Services

9%

Access

ories

3%

iPod

3%

BY PRODUCTAmericas

30%

Europe

18%

Asia-

Pacific

(Australia

& Asia)

18%

Greater China

12%

Rest

of Asia

Pacific

5%

Retail

(U.S.,Canada,

Japan,

U.K.)

10%

Japan

7%

BY GEOGRAPHY


4/13

Page 3of 12

iPhone:

Global

Smartphone

Industry

The handset

(including both

smartphones and

non-smartphones)

industry is

dominated by the

top 10 handset

maker. They

accounted for 68%

of total shipments


in 2012 and 85% of total handset sales. Major Smartphone manufactures are Samsung (Korea)

which in 2012 delivered 218 million shipments or 30% of global shipments. All other non-top 10manufactures combined to deliver 138 million shipment, 19%; Apple (US): 138 million shipment,

19%; Nokia OYJ (US): 35 million shipment, 4.85%; Blackberry (Canada): 33 million shipment,

4.37%. According to IDC and Bloomberg, mobile phone industry outlook, global smartphone

shipments are projected to increase at a 19% CAGR from 2012 to 2017. Future regional

smartphone shipments CAGR is highest in Latin America (26%) and the Asia Pacific (25%),

followed by EMEA (14%) and North America (8.9%).

iPhone is the most important product for Apple as it contributes of revenue and of net income.

Apple has great pricing power as evidenced in iPhones high gross margin ratio. Recent years

incremental growth came from emerging markets, but it will likely plateau in a few years.

Apples high gross margins ratios is unsustainable due to two factors:


5/13

Page 4of 12

1. Pressure from customers: Apple has seen it is becoming increasing difficult to chargecustomers a high premium especially when other products are increasingly comparable in

terms of hardware quality.

2. Threats from other operating systems such as Android, as we can observe from the chartbelow, sales of Android smartphones increased fivefold from 2Q11 to 3Q13. Though IOS

smartphone also increased steadily. Apples biggest threat comes from lower priced

Android phones and ever better Android app stores that provides software to compliment

smartphones.

Source: Gartner


6/13

Page 5of 12

Source: IDC

Source: IDC, Gartner, TechThought

Used historical shipments and

industry forecast to add a stepfunction to iPhones market share in

each region. In summary, Apple is

forecasted to lose 3% share every

year in NA, gain 1% in LA, remain

constant in EMEA markets, and gain 2%

in Asia/Pacific.

0

200

400

600

800

1000

1200

1400

2014 2015 2016 2017 2018

Global Smartphone Shipment

North America

Latin America

EMEA

Asia/Pacific

North

America,

43.0%

Latin

America,7.0%

EMEA,

15.0%Asia/Pacific

, 10.0%

North America Latin America EMEA Asia/Pacific

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

APPLE'S SMARTPHONE

MARKET SHARE BY REGION


7/13

Page 6of 12

Source: IDC, Gartner, Bloomberg

Mac and iPad:

Global Computer Hardware Industry

Based on the computer industry report from Bloomberg, the global computer hardware slump

is unlikely to end in 2014, mainly due to Open Compute and slowing innovation. Consequently,

computer hardware manufactures pricing power diminishes and growth outlook remain

austere. Tablets are becoming more popular as a substitute for PCs and will grow at the

expense of the PCs. Another trend in this industry is decreasing in average selling price (ASP),

primarily due to intensified competition and lower manufacturing costs.

Apple is a market leader in this industry with a dominating position in a set of large, growing

and profitable markets. The sell price of its PCs will decrease in the future, as a continuation of

past trends. Its PC, iPad and iPad Mini remain strong in terms of market share and pricing

power, as shown from the below table. (share of tablets and ASP).


8/13

Page 7of 12

Source: IDC, Gartner, Bloomberg

Others:

Assumptions and Rationale

Assumed iTunes/Software/Services, Accessories and iPods future revenue to be % of iPhone,

iPad and Macs revenue, because those products are deemed as compliments to

aforementioned products. Historical results also suggested strong correlation.


9/13

Page 8of 12

Pricing

Revenue forecast in the excel models were expressed as Unit shipment* ASP. As discussed

above, the global IT hardware industry is fostering intense competition because of

commoditization of the smartphone sector.

In projection, a step function was used to reflect the ASPs downward trend over time. Annual

step (% of increase or decrease) of hardware products are: iPhone -8%, iPad -5%, Mac -3%. In

summary, Apple products selling price trend is in line with the forecast in the chart below,

though in a higher degree, as Apples products are currently selling at higher premiums.

Source: IDC, Bloomberg Industries


10/13

Page 9of 12

Profitability

The overall gross margin ratio of Apple averaged 43% for the past three years, which is much

higher than the industry average. The past three year gross margin for global smartphone

comparables were 28%, and 17% for global hardware comparables. To simplify and to be

reasonable, Apples overall gross margin should converge to the industry average. The gross

margin ratio 23.2% was calculated based on the assumptions that iPhones account for 60%, and

Computer hardware (Mac, iPad, iPod combined) for the remaining 40%.

Valuation

5 year CAGR:

Revenue -4.2%, Gross Profit -12.7%, Net Income -12.7%.

50,000.0

100,000.0

150,000.0

200,000.0

250,000.0

FY 2014 FY 2015 FY 2016 FY 2017 FY 2018

Fundamentals

Revenue

Gross Profit

Net Income

FCF


11/13

Page 10of 12

Other Assumptions:

1. The cost of revenue included depreciation and amortization expenses already. Inorder to better reflect manufacturing costs, cost of revenue was categorized into:

cost of revenue net of dep & amort, and dep & amort expenses.

2. CapEx, as a % of sales, used the past three years historical average as a drive.3. Apple does not disclose depreciation and amortization separately. Depreciation was

computed backwards from year end accumulated depreciation minus year

beginning accumulated depreciation. Future depreciation expenses were forecast

as a % of net fixed assets, because the historical ratios suggest strong correlation.

4. In the same manner, amortization was calculated from total depreciationamortization- depreciation expenses. Amortization was forecast as a constant

number over the period because Apples net investment in intangibles was

negligible, less than $1 Billion (according to the MD&A, most of the intangible assets

were amortized using a straight-line method over 20 years).

5. Other investment activities include many types of different variables that were hardto forecast e.g., acquisition of business, proceeds and purchase of short term


12/13

Page 11of 12

marketable securities; therefore, I assumed the investment to be a constant over

the future periods.

6. Same applied to other non-cash adjustments on the cash flow statement7. Other non-cash working capital and other non-cash adjustments deviated from

historical trends as I reclassified some items in each category.

8. Dividend policy: from the 2013 10K, MD&A (p 19), management expected the cashdividend payout to remain constant or grow in the future. The Quarterly dividend is

expected to be $2.65 per share and about $2.6 Billion to be paid out to all

shareholders. Since, Apple has accumulated a huge amount of cash, it is like Apple

will increase its dividend payout going forward.

Opportunities

1. New products and innovations (MD&A): iPhone was an instant hit after its release in2007, and the iPad introduction renovated the global hardware industry. iPad mini

targets at price sensitive customers especially those in the emerging markets, and it has

boosted the iPad sales in 2013. Apple is widely perceived as a technology innovator and

game changer; surprise factors should be included in the valuation.

2. Market expansion: Apple already has leading market shares in developed countries, 43%in US, 37% in GB, 28% in Australia. These markets are saturating, and customers may

switch to other brands. Emerging markets such as Latin America, China and India

provide some room for its future growth. Apple products were recognized as a product

of status, which means Apple can still charge a high premium. Moving forward, Apple

will lose its pricing power, and therefore needs to stimulate sales with lower selling

price.

Risks to the Thesis

1. The greatest risk comes from intensified competition by hardware producers such asSamsung, LG, and software platforms such as Android and Windows. These factors will

put pressure on Apples future product shipments and gross margin.


13/13

Page 12of 12

2. Product cannibalization: the global computer hardware is maturing, and customers havesteered away from traditional PCs to portable devices such as ultra-books and tablets.

Apples iPad and ultra-book sales may grow at the expense of its Mac PC sales.

3. Supply chain risk (from MD&A and Bloomberg): Apple has a total of 260 suppliers, but afew dominate, such as Hon Hai Precision, Pegatron Corp and LG display. In addition,

rising material costs such as aluminum and labor costs will affect Apples bottomline.

4. Foreign exchange risk: 70% of Apples revenue came from non-US regions, thereforeadverse foreign currency exchange rates in respect to US dollar will impact Apples net

income. For the past three years, foreign exchange losses were immaterial due to

hedging. (10K MD&A)

Documents

Apple Equity Research Report Final