OZANKUTSAL
“Low-hanging fruit” is an expression often used to denote an easy task. This weekend’s revelation from Warren Buffett’s Berkshire Hathaway (BRK.A, BRK.B) that the company divested a near-50% stake in its Apple Inc. (NASDAQ:AAPL) holdings is, to me, a clear sign that Berkshire simply plucked the lowest-hanging fruit in its portfolio to sell off.
Although that does lend credence to my Sell thesis, as outlined in my April 2024 article titled, Apple: Shiny No More — Sell Now And Keep Your Profits Thus Far, I’m not here to say I told you so. Indeed, I’ll admit that AAPL actually went on a strong rally right after those calls (mine and the earnings), climbing from the at-publication price of $170 to all-time highs above $230. Since then, the stock has lost ground and is currently trading in the $208 to $210 range.
That being said, I reiterate my sell rating today. I do this largely for the same reasons I mentioned in my earlier article — shareholder equity erosion from growing liabilities versus shrinking assets, the lack of any meaningful innovation, and generally unstable profitability and cash flow growth. However, I will also add because the situation today is a tad more precipitous than it was in April when I penned the last piece. I’ll also introduce some fresh observations in this analysis of Q3 earnings. It’s not a full-fledged review, but there are a few relevant figures from the last reported quarter that I’d like to include in my ongoing bearish story.
To AAPL perma bulls, this is my message: I’m not attempting to bash the company in any way, but the market’s exuberance over this mature company that’s resorting to financial engineering over any meaningful innovation is unjustified. At the end of the day, it’s still a hardware company that’s also benefitting from a services ecosystem, but in any kind of recession scenario, investors are going to sell large portions of their holdings, just like Berkshire did. I don’t claim to know the reason it sold off hundreds of millions of AAPL shares, almost halving its position. Others who know better than I do have stated their positions on the matter (emphasis mine):
Reuters says this (emphasis added):
Berkshire’s results released on Saturday suggest the 93-year-old Buffett, one of the world’s most revered investors, is growing wary about the broader U.S. economy, or stock market valuations that have gotten too high.
The New York Times says this (emphasis added):
Berkshire often lets cash build up when it can’t find whole businesses or individual stocks to buy at what it considers fair prices. Its cash may also signal concerns about the broader U.S. economy.
I don’t like to speculate. However, what’s clear to me from this divestiture is that Berkshire decided to liquidate a massive chunk of its AAPL holdings. That should be a warning not only to AAPL investors, but anyone invested primarily in U.S. securities. Coming back to the AAPL narrative, however, I see issues that persist, and this is not the time to be heavily invested in a company that’s still struggling to find its “next wind.”
Persistent Issues Worsen in Q3
Apple hadn’t released its Q2 or Q3 results when I last covered it, but after looking at these two quarters, my conviction is firm on certain things.
First, shareholder equity is now down to $66 billion. Although it initially went up to around $74 billion in Q1 and Q2 and is still up on a YoY basis, the hit in Q3 from negative retained earnings (accumulated deficit) is worrisome.
Moreover, Apple has been divesting some of its long-term investments — to the tune of a near-9% reduction, down to about $91 billion from the over $100 million in Q1. Net PP&E is down $10 billion as well, and collectively, these developments have reduced its total assets by more than $20 billion over the past three quarters. Things aren’t looking rosy on the liabilities side, either, but the company has been paying down some of its long-term debt, bringing total liabilities down by $10 billion on a YoY basis. That was one of my worries in Q1 when total liabilities were approaching $300 billion. Nice bit of financial engineering there, but it only masks the problem to a degree.
While I don’t really put much stock in the current ratio for such large companies with ample cash hoards, which is about $62 billion in cash and short-terms, the deterioration in Apple’s short-term liquidity shouldn’t be ignored. This is especially when it’s in a net debt position to the tune of $51 billion rather than a net cash one.
Let’s be clear. Whatever I’m pointing to aren’t serious issues, but they do tell an interesting story when you look at them collectively. My conclusion is that Apple is carefully trying to keep its numbers in good shape, and the source of that is its revenue profile, which we’ll discuss next.
The chief issue with revenues is its core segment, Products. Product revenue growth rates have been flagging for a while, and if you look at Q3 figures on a three- and nine-month basis, the problem should be amply clear.
Product revenue growth figures have been weak since the start of the fiscal year, and the only reason the company can stave off a net sales decline is the performance of its services business.
But let me pose a question here: since Services are directly dependent on the install base of iHardware, at what point might weak revenue growth from products fail to support growth in services? Sure, you can argue that its user base is extremely sticky. There are regular gadget refresh cycles, and some things Apple is doing with Apple Intelligence should help bolster iPhone revenues, Services revenues themselves are sticky because they come from subscriptions, and so on.
My view, however, and I’m sure I’m in the minority with this audience, is that Services aren’t going to keep growing at such a rapid pace when hardware sales growth isn’t fully supporting them. It’s logical and undeniable. At some point, Services growth will start to falter. What will investors make of AAPL’s +8x price to forward sales multiple then? For that matter, with book value (shareholder equity) already declining, how is a price to TTM book value of 47x being justified by the most adamant of bulls?
Honestly, I don’t know the answer to those questions. What I do know is that this is not a company I want my money to be “stuck” in. Long-term investors have made a killing, no doubt, but it’s time to look at the facts squarely in the face and do what needs to be done. Did Berkshire do exactly that? I’m not qualified to answer that, but I do know that it was willing to sacrifice those 390 million shares just to beef up its cash position, and BRK investors understand these decisions aren’t taken casually.
Moving on to cash flows, the first thing that caught my eye was how capex has been on the decline for the past decade. In stark contrast, companies like Nvidia (NVDA), that derive most of their revenues from hardware sales are increasingly spending more and more, and they’ve been doing that for several years.
Apple is ill-prepared for the future, in my opinion. Its declining capex is another sign that the company is just about managing to show borderline growth, keep its cash flows strong, and keep buying back shares at a ridiculous pace.
On that last point. Returning money to shareholders, you say? Well, I just see it as a way of ensuring that the stock price has adequate support.
I’m sure some investors, at least, are wishing that the buyback yield was actually a dividend yield on top of the 0.48% forward yield for the stock. That way, you get to see real money rather than having to view it on your screen as unrealized gains. Worse, you definitely don’t want buybacks to be masking what might otherwise be poor price performance, and I dare say that’s what’s happening here.
Confirming My Sell Thesis
I know it’s completely out of context to just show a one-year total return chart and claim that Apple is done outperforming the market. That’s very far from the truth. Apple will continue to outperform in the future, but the extent of its outperformance is highly dependent on developments that aren’t happening right now. Innovation is at an all-time low, capex doesn’t look like a priority, and the impressive buybacks are designed to do just that — impress.
The signs are plentiful. You just have to want to see them. As I said before, I’m not bashing the company. It’s a company that was great at one time and is not so great right now, and the needle is slowly moving closer toward the latter instead of the former. That’s the main reason I remain bearish on the name.
Naturally, if you’re a long-term shareholder, you may have a massive capital gains tax burden to worry about. You might also hesitate to cull your position for other reasons. I’m not saying sell your entire position; my point is simply that this is not a ship you want to take a really long vacation on. It’s not sinking, but there are holes in the hull, and I don’t see management trying to plug those holes. All I see, in all honesty, is them trying to create more ballast, so the ship stays afloat longer. No full steam ahead here, unfortunately.