I rate Apple Inc. (NASDAQ:AAPL) a hold due to significant headwinds heading into June-Q earnings, shipment forecast cuts by key suppliers, and overvaluation based on relative and absolute valuation metrics. In the near-term, AAPL faces headwinds that have caused analysts to forecast a noticeable deceleration in growth. Investors in AAPL could face a disappointing June-Q earnings report because of headwinds such as China’s Covid-19 lockdown, lost sales in Russia, and rising freight and material costs.
June-Q Earnings Headwinds
Apple is facing significant headwinds due to China shutdowns, the war in Ukraine, and inflationary pressure. Apple is highly reliant on China for 90% of the components for their products. AAPL faces the opportunity cost of missed sales due to an inability to meet demand. The company indicated at March-Q that the shutdowns will cause up to $8 billion in lost sales. Additionally, Apple is estimated to lose $3 million a day in sales since they halted operations in Russia. This amounts to $1 billion annually, but is still less than 1% of their total revenue.
With over $200 billion in cash on their balance sheet, Apple will be significantly hindered by inflation. At YE21, it was estimated that Apple lost over $1 billion attributed to fluctuations in exchange rates and a weakened dollar. Inflation is increasing at record levels and these fluctuations will weaken the value of AAPL’s stockpile of cash. Furthermore, inflationary pressure have also increased costs for the production and logistics of their products. Suppliers are hiking prices at an alarming rate, and the global freight rate index is up almost 400% from January 2019 to March 2022 (see below).
Supply Chain Analysis
If you look at the supply chain pictured below, the image illustrates the breakdown of AAPL’s costs attributed to each supplier. Hon Hai Precision (known as Foxconn tech Corp in U.S.), Pegatron, and Quanta Computer make up 60%, 15% and 11% of AAPL’s costs, respectively. All of which are contract manufacturers. Foxconn says that the company’s Zhengzou, China, location remains unaffected from the China lockdown, but they recently had to shut down their Kunshan, China, location.
In contrast, Pegatron (OTC:PGTRF) provided a bleak outlook by cutting their shipments forecast by a quarterly decline of 5%-10%. Quanta computer just partially resumed operations in China in Shanghai, after a shutdown due to lockdown measures in the city. This makes me believe that AAPL will have a weak June-Q earnings report, missing out on valuable sales in the near-term due to lack of supply.
Taiwan Semiconductor (TSM) makes up 7% of AAPL’s costs and the company faces strong demand for their chips. While strong demand should cause chip prices to drop, prices have actually increased in FY22, increasing 9%-10%, with the price index increasing to 59.9 from 54.7 at FYE21 (see below). This increase in price could squeeze margins, leading to further increases in the prices of AAPL’s products. Additionally, it could place a drag on demand due to decreases in discretionary spending as a result of economic deterioration.
Because of the headwinds and supply-chain issues mentioned above, analyst estimates indicate a stagnation in AAPL’s top-line for FY22 and FY23 (see below). Analysts estimate that FY22 and FY23 revenue will grow by 7.8% and 5.6%, respectively. They do, however, forecast healthy margins for the next two years.
AAPL’s EBITDA margins of 33% will continue to make them highly profitable, but this will be offset by the lack of supply to drive sales. Furthermore, they could face margin squeezes due to higher costs of materials and freight. Assuming they continue to increase their product prices, there could be a decrease in demand, especially if there is a decrease in discretionary spending due to recession.
Overvaluation of AAPL’s Assets
Currently, I believe that AAPL investors are overpaying for the company’s assets. To illustrate this overpayment, I valued AAPL’s segments by multiplying the FYE22 revenue of each segment by the average EV/Rev FY21 multiple of several companies with similar operating assets. For AAPL’s iPhone segment, I calculated the average EV/Revenue multiple between Google (GOOG, GOOGL), Android, and SSNLF, arriving at 7.7x sales (see below).
For AAPL’s Mac/iPad segment, I calculated the average EV/Revenue multiple between HP and Dell, which was 0.7x revenue (see above). For the wearables/home/accessories segment, I used GRMN’s EV/Rev multiple of 2.9x. And finally, for the iTunes/AppStore segment, I calculated an EV/Revenue multiple of 3.76x for the Google Play segment.
After calculation, my forecasted asset valuation model for FY22 indicates that AAPL’s total assets are worth $2.02 trillion, which is less than enterprise value by $282 billion (see below). This implies that investors in AAPL are overpaying by $282 billion for the company’s operational assets.
When comparing AAPL’s valuation multiples to big tech (see above), AAPL seems over-valued (see below), but fairly valued against Microsoft (see below). Against AAPL’s P/E ratio of 23.1x, MSFT has a P/E ratio of 24.7x. Against their EV/EBITDA multiple of 17.2x, MSFT also has a multiple of 17.2x. And relative to their Price/Book of 5.7x, MSFT has a multiple of 12x, representing undervaluation.
When comparing AAPL’s valuation multiples to Google, AAPL seems overvalued. Against AAPL’s P/E ratio of 21.x, Google has a multiple of 17.6x (see below). Against their EV/EBITDA multiple of 17.2x, Google has a multiple of 11.2x. And relative to their Price/Book of 5.7x, Google has a multiple of 6x. In this case, Apple seems fairly valued.
When comparing AAPL’s valuation multiples to Samsung (OTC:SSNLF), AAPL also seems overvalued. Against AAPL’s P/E ratio of 21.x, SSNLF has a multiple of 8.9x (see below). Relative to AAPL’s EV/EBITDA multiple of 17.2x, SSNLF has a multiple of 2.9x. And compared to their Price/Book of 7.7x, SSNLF has a multiple of 1.3x.
According to five of the main multiple valuation metrics, AAPL is trading at a significant premium relative to industry averages. Currently, AAPL’s P/E ratio indicates that its trading at a 44% premium relative to the industry mean. Furthermore, comparing AAPL’s EV/EBITDA multiple, EV/EBIT multiple, and EV/Revenue multiple relative to industry averages indicates a premium of 71%, 61%, and 73%, respectively.
When comparing AAPL’s valuation multiples to competitors that operate with the same product offerings, the company seems overvalued. In comparison to AAPL’s P/E ratio of 23.1x, the forward P/E ratio of SSNLF (12.5x), HP Inc. (HPQ) (5.8x), and Dell (DELL) (4.8x) indicate overvaluation. In comparison to AAPL’s EV/EBIT multiple of 18.9x, the EV/EBIT multiple of SSNLF (7.4x), HPQ (7.3x), and DELL (6.3x) also indicate overvaluation.
Regarding AAPLs EV/EBITDA multiple of 17.2x, competitor multiples of SSNLF (4.5x), HPQ (6.4x), and DELL (6.3x) indicate that investors are paying a premium. And finally, relative to AAPL’s Price/Revenue multiple of 5.7x, the Price/Revenue multiple of SSNLF (3.2x), HPQ (0.6x), and DELL (0.2x) also indicates that the company is trading higher than industry peers.
Discounted Cash Flow Analysis
For my discounted cash flow model, I used analyst estimates of $109.5 billion and $114.5 billion for free cash flow in FY22 and FY23, respectively. I made assumptions of a 10% CAGR for FCF in FY24 and FY25.. After placing these assumptions into my DCF model, I arrived at the following cash flows for FY22 through FY25:
For my discount rate, I calculated AAPL’s WACC to be 8.95% using their current market capitalization and market value of debt (see below). After using the CAPM formula to calculate AAPL’s cost of equity, I arrived at market risk premium of 5.09% by taking the difference between an expected market return of 8% and the US Treasury 10Y. To calculate the market value of debt, I used AAPL’s interest expense and book value of their total debt at YE21.
After applying a WACC of 8.95% to my forecasted future cash flows for AAPL, I arrived at an intrinsic value of $138.48 per share (pictured below). This represents 5.89% downside from the current share price. My price target falls under the lowest price target ($145) of equity research analysts. Twelve-month price targets of analysts range from $145 (1.4% downside) to $219 (49.6% upside). Additionally, the median price target of $190.50 represents 29.6% upside.
AAPL faces a number of headwinds in the near-term. Continued shutdowns in China could plague the country for the foreseeable future, placing a drag on AAPL’s bottom line. Suppliers have noted further shutdowns, as well as forecasts for decreases in shipments. This lack of the ability to meet demand has led analysts to estimate a stagnation in growth through FY23.
Additionally, AAPL faces the issue of increases in material and freight costs. Continued increases in materials such as semi-conductor chips will cause AAPL to continue increasing prices. This increase in price could hinder demand as we drift closer to recession. Due to these significant headwinds, Apple will see a stagnation in growth in the near-term that will leave investors disappointed. However, Apple has innovated in the past, and I believe that it has enough liquidity to invest and grow in the long-term.
AAPL is a bit expensive at current prices, but is a blue chip stock that I believe attracts great talent to innovate in the future. They are highly liquid with cash and investments of $200 billion, allowing them to invest in capital projects to drive future growth. However, AAPL faces a number of significant headwinds that are out of their control. I am expecting a disappointing June-Q report, but I believe in Tim Cook to lead AAPL through these headwinds and come out unscathed. Hold AAPL.