Apple Inc. (NASDAQ:AAPL) hasn’t been immune to the stock market selloff with shares down about 15% from its 2021 high despite solid earnings over the past year. The challenge is the more uncertain forward outlook and concerns about whether the company will be able to maintain its growth momentum.
Apple’s latest quarterly result beat expectations although there is a sense the operating environment is set to weaken into the second half of the year. The company remains exposed to trends in consumer spending that is being pressured by persistent inflation and rising interest rates. Our take is that even following the selloff, we view the stock as still overvalued with risks tilted to the downside, particularly against the current consensus estimates that appear too optimistic.
AAPL Financial Recap
The company reported fiscal Q2 earnings on April 28th with GAAP EPS of $1.52, up 9% year over year and $0.09 ahead of expectations. Revenue of $97.3 billion climbed 8.6% from the period last year and was also $3.3 billion above consensus.
This was a record Q2 for the company which continues to benefit from an ongoing shift towards a more services-based model beyond core iPhone and Mac hardware. For context, services which include advertising, AppStore, AppleCare+, cloud, digital content, and payment services now represent 20% of total revenues, up from 19% last year. Nevertheless, with the exception of the “iPad”, all major sales categories saw growth.
The result on the services side has led to a trend higher in margins over the last several years with the company more profitable than ever. The gross margin reached 43.7% compared to 42.5% in Q2 2021. On the other hand, the operating margin this quarter at 30.8% was roughly flat from 30.7% last year. This considers higher spending from Apple across R&D and SG&A as total expenses climbed 19% y/y.
It’s worth noting that the company hiked its dividend by 5% to a new quarterly rate of $0.23 per share. The forward yield on the stock is approximately 0.6%. Apple has historically favored share buybacks in its capital allocation and increased its buyback authorization by $90 billion on top of $17.6 billion in the existing program. The annualized dividend and total buyback authorization represent a shareholder yield of 5.3%.
What Are The Consensus Estimates For Apple?
One of the headlines from the last earnings report was management’s comments indicating some near-term headwinds leading to softer guidance. From the conference call, Apple cited everything from ongoing supply chain disruptions and the latest Covid surge in China limiting economic activity in the region as clouding the outlook. Separately, the Russia-Ukraine crisis has forced the company to pause all sales in Russia with a direct impact on growth for the rest of the year. All in all, the setup is for a deceleration into Q3 and the rest of 2022.
What stands out to us when looking at AAPL is that even with the major macro developments over the last few months, the consensus estimates have been relatively resilient. For example, the market forecast for AAPL’s fiscal Q3 revenue at $82.8 billion, representing a 1.7% y/y growth has been lowered by just 3.7% over the last 90 days. This apparently includes a loss of around 1.5% to total sales from business in Russia as noted in the conference call. Based on quarterly estimates through Q4 2023, consensus revenue and EPS are still up for nearly every quarter compared to levels six months ago.
Our point is that these estimates may be too aggressive in the current environment making it more likely that Apple underperforms. To be clear, if there was ever a company that deserved the benefit of the doubt, Apple has earned that right with a long history of beating the consensus EPS, including every quarter for the past four years.
This earnings surprise history may be creating a false sense of security among investors. Examples this year from tech giants like Netflix Inc. (NFLX) to Amazon.com Inc. (AMZN) highlight that no company is safe from a big miss in earnings forever.
Is Apple Stock Undervalued Or Overvalued?
Betting against Apple has never worked, but there is a case to be made that this time is different. There are several reasons to believe the broader sales trends are slowing. This week, China reported April retail sales in the country contracted by -11.1% and below expectations amid strict Covid lockdowns. For context, China represented 19% of Apple’s global business in Q2. In the U.S., consumer sentiment has taken a hit with 40-year high inflation squeezing discretionary budgets.
The bigger concern here is that conditions can still get worse. The U.S. and global GDP growth estimates from groups like the International Monetary Fund and even the Fed have trended lower this year. There is a lot of uncertainty in regards to how deep the slowdown will be. Even in just a soft technical recessionary environment, a loosening labor market and tighter credit conditions accompanied by falling consumer spending will result in weaker sales for Apple.
The current 2022 revenue consensus approaching $394 billion, if confirmed, will represent an increase of 7.7% over 2021. The market is forecasting EPS to reach $6.15, up 10% compared to last year with an expectation that stronger margins lift earnings. Looking ahead, the market expects revenue growth of around 5% through 2025 with earnings also trending higher. We’re skeptical that Apple can hit these targets.
In our view, AAPL is overvalued because we see the current growth headwinds extending through next year and leading to weaker than expected sales, margins, and earnings. The stock trading at a forward P/E of 24x appears expensive, particularly in the subdued growth outlook. The 1-year forward P/E closer to 22.5x based on the consensus 2023 EPS is also above the stock’s 5-year average for the metric closer to 20.5x.
One bullish argument for the multiples expansion in AAPL compared to levels several years ago considers the higher margins with the growing services business as discussed. At the same time, revenue and earnings growth expected in the mid-single-digits for the foreseeable future keeps the company out of a “growth” category. The dividend yield for the stock doesn’t quite stand out as a value pick either. We believe Apple continues to get too much credit for its “blue-chip” status which is reflected in an excess valuation premium that might not stand up in a real recession.
AAPL Stock Price Forecast
From a technical perspective and the charts, it’s clear that shares of AAPL have broken down a trend line that was in place since mid-2020. The trading action here mirrors the broader market that has the bears in control. In many ways, the next direction the stock takes is going to be a macro call.
For investors that are very confident the market is going to stroll over the current proverbial wall of worry, Apple should be able to lead higher as risk sentiment and growth expectations improve. It won’t be easy, but indications that inflation is trending lower and possibly a resolution to the Russia-Ukraine crisis could be enough for stocks to gain momentum.
With a more cynical view, economic indicators deteriorating through the next several months should lead to earnings estimates getting slashed lower. Anecdotally, there are good reasons for a large segment of customers to put off upgrading to the next iPhone this year. We also see a downside to iMac and wearables sales trends against more difficult comps from pandemic purchases. While services have been a big story, it’s important to remember that the business still revolves around the hardware-based ecosystem. Consumer discretionary is not a segment we’re particularly optimistic on.
Is AAPL Stock A Buy, Sell, Or Hold?
Apple could very well be the greatest company in the world and with a positive long-term outlook which we’re sure will bring many innovations. That said, the near-term outlook through at least the rest of the year looks tough. We rate AAPL as a sell with a price target of $120 for the year ahead.
Putting some numbers behind our forecast, in a scenario where 2022 EPS ends up about 5% lower than the current consensus estimate, meaning the final annual result is ~$5.84, a 20x forward P/E multiple gets AAPL down to $117. Poorer sentiment towards the stock within the broader market can force a valuation-multiples contraction into a more volatile earnings environment.
For the upcoming quarters, margin levels and sales trends will be the key monitoring points. China is a big risk to watch considering the deeper geopolitical implications and the importance the country represents to Apple’s global strategy.