Very interesting views/comments abour Apple shared by Wedgewood Partners in their latest letter to investors (h/t Dataroma).
« 2012 was the year that Apple was “out-sized.” In our 24/7/365 world of non-stop information flow, 2012 was a bandwidth firehouse when it came to Apple. The vitriol between Apple “fan-boys,” who believe that the Company can do no wrong and Apple “haters,” who believe that the Company’s best days are behind them, reached a new high (low?); even the firing of a top executive quickly led to rumored plotlines and intrigue worthy of Shakespeare. More than previous years, it seemed that anything and everything associated with Apple was out-sized, which included the Company’s early year earnings “beats” and its late year earnings “misses,” the stock’s early year gain and its late year decline, as well as the Company’s product successes (iPhone and iPad mini) and perceived product failures (iOS Maps). The naysayers are absolutely sure that Steve Jobs would have never released such a flawed product as iOS Maps. Furthermore, Steve Jobs was absolutely convinced that a smaller version of the iPad would be a flawed product. Well.
The learning curve of iOS Maps has not been as steep as initially believed, and the iPad mini is such a success that the Company is feverously ramping up supply production to meet out-sized demand. But even for Apple bulls like ourselves must admit and recognize that the “expectations bar” is higher for the Company than literally any of their competitors. Early versions of Mobile Me, iCloud and, yes, iOS Maps have not been “insanely-great” – not even close. So while we agree that Apple is far from blemish free, we do ardently disagree with the knee-jerk verdict that the Company, post-Steve Jobs, must be irrevocably on a path similar to Polaroid’s decline and demise post-Edwin Land. The opposing view/question will the Company’s future be more similar to the growth and prosperity of Disney post-Walt Disney? In our view, Apple circa-2012, it is far too soon to tell. But both tales are worthy of our study and conjecture.
So, if we can pull ourselves out of the gravitational pull of all-things-Apple, we will try to summarize our views and opinions on both Apple the company and Apple the stock. In our opinion, Apple-the-company continues to operate at a level that is quite unique (and envy) in the annals Corporate America. The Company exited fiscal 2011 (September) with a revenue base of $108 billion – up 66% over 2010; and an earnings base of $26 billion – up 85% over 2010. So, despite all of the strum und drang during 2012, Apple generated revenue, earnings and earnings per share growth of 44%, 61% and 59%, respectively. 2012 return on invested capital at +42% speaks to the Company’s unrivaled competitive position. Even after spending billions on capital expenditures, the Company still generated $41 billion in free cash flow – an increase of 38%. The 1st National Bank of Cupertino is now sitting on Ft. Knox-like pile of liquid assets of more than $120 billion. Assuming just single-digit growth rates in the Company’s free cash flow generation will put Apple’s cash-liquidity hoard in excess of $200 billion by mid-2014. How big is $200 billion? The current market caps of both Google and Microsoft are approximately $225 billion.
Driving this stellar performance, in our opinion, was no more than “business-as-usual” for the Company. The global expansion of the Company’s Mac and iOS ecosystem of products (iPhone, iPad and iPod Touch), services, iCloud and the App Store – intertwined with their +390 industry leading stores – continued to facilitate the growth of new customers, as well has the repeat purchase of tens of millions of loyal Apple customers. Indeed, this uniquely competitively advantaged asset of Apple – backboned with +700,000 Apps, +400 million iOS users and +200 million iCloud users – was the driving force of the sale of over 200 million iOS devices in 2012. Not to be out done by the success of iOS, the Company’s Mac franchise continues to grow at multiples of PC growth. In fact, given that +80% of Mac unit sales are laptops – and with the launch of the App Store on Mac OS, plus the ubiquity of the iTunes Store on Macs – the line between Macs and iOS devices has become intentionally blurred.
China will be the short list of focus for the Company in 2013 – and beyond. As recently as 2009, China accounted for about $770 million in sales. In fiscal 2012, China generated $22.8 billion for the Company. Apple currently has eleven stores in China – six were opened just last year. Per capita, Apple only has one store per every 216 million people in China. The Company expects to significantly exceed its initial goal of 25 Apple stores in the future. The Company also has a network of over 2,000 authorized offline specialty retailers. In terms of context, there are over 3,700 KFC restaurants in 700 cities across China; Starbucks has more than 570 locations in China. According to McKinsey Insights China report on “Understanding China’s Love for Luxury,” the luxury market in China is projected to reach $27 billion by 2015 – or as much as 20% of the global luxury market. The iPhone is a unique status symbol in China, particularly among youths. Indeed, the average smartphone user in China is 22 to 24 years old, compared to 35 to 40 years of age in the U.S. China could well be the Company’s largest market in little more than three years.
The Company exits 2012 with a complete product refresh – the oldest hardware product in Apple’s portfolio is a mere 5 months old. Apple-the-stock has been on a roller coaster ride for all of 2012. At the stock’s 2012 peak the shares were up 74% – and finished 2012 -28% off of the mid-September highs. During the Company’s winter of discontent, consensus expectations for fiscal 2013 have fallen over the past few months and are now just 10% greater than the $44 per share the Company earned in 2012. The steep decline in the Company’s expected 2013 growth rate embedded in current earnings expectations is far too dire in our opinion. In addition, with the stock currently at $520, the market implied revenue growth at current prices infers a deleterious decline in the Company’s competitive position. But if in fact consensus expectations do come to pass, the stock is currently valued at little more than 10X 2013 earnings. In our view, the stock possesses an asymmetric risk/reward profile worthy to be the Fund’s largest holding. »
Surprising facts about Apple: while the stock went from ~100$ a share early 2009 to 445$ now, its 12 month forward P/E ratio declined to ~10x from ~16x. A paradoxical de-rating despite the flow of new products and the very high level of cash generated by the business. Are we witnessing a renewed buying opportunity ?