Apple (NASDAQ: AAPL) has been one of the best and strongest investments in most of the past 20 years. When the iPhone came out in 2007, it started making money that most other companies can. only dream and now they are bringing in billions of things like their service segments which are bigger than what some other companies are bringing in total.
But last year there was a warning sign that I’ve been watching for a long time – as they lose their cash reserves for share buybacks and other compensation, they lose their revenue advantage. of investment and interest they generate and now, for the very first time, they are paying more interest than they are earning.
That’s not so bad on its own, considering they rake in around $100 billion in net income while paying just under $3 billion a year in interest charges. But with the lack of innovative new products, they rely more on the incentive of telecommunications companies to sell their new iPhone than on organic excitement.
Let’s dive into the problems I see.
Debt charge and interest charges
Beginning in 2013, the company began to take on long-term and short-term debt as interest rates approached zero to fund its operations while keeping cash overseas and investing it to generate interest, which more than covered interest expense at low interest debt. Since then, the debt has fallen from around $16 billion to just under $110 billion, down to around $95 billion as of the date of their last financial report.
But then the Federal Reserve started raising interest rates and the company started paying more interest. After the repatriation holiday in 2017, Apple brought back much of its overseas cash that was invested and spent the vast majority of it on stock buybacks and other shareholder-friendly activities, which reduced their interest income.
Even though, as I mentioned earlier, the company reduced its debt from $110 billion to $95 billion, its interest expense for the same period fell from $2.6 billion to $2.8 billion. of dollars. While these numbers pale in comparison to their earnings and revenue generation, it is somewhat concerning in the long term given the direction interest rates are heading and the low cash reserves the company has.
Cash, investments and interest income
The company’s cash and cash equivalents and short-term investments have grown for the longest period as the company has built up cash, but in recent years the company has announced that it intends to reach a neutral position in terms of cash and to spend it to finance actions. buyouts and other shareholder-friendly activities.
Apple had more than $100 billion in cash and short-term investments as of September 2017, which has fallen to less than $50 billion to date.
The most interesting part of this is that the company’s investments declined after the repatriation holiday in 2017 allowed companies to bring in cash at record tax rates, which was mainly used for share buybacks.
Apple had nearly $200 billion in long-term investments in September 2017, which then slowly declined and hovered around $100 billion.
The result: all about interest rates
This has resulted in lower interest income for the company as their interest expense is expected to continue and increase:
|Costs||$2.32 billion||$3.24 billion||$3.58 billion||$2.87 billion||$2.65 billion||$2.78 billion|
|Revenue||$5.20 billion||$5.69 billion||$4.96 billion||$3.76 billion||$2.84 billion||$2.73 billion|
(Source: summary of the company’s income statement)
During the COVID-19 pandemic, interest rates fell to zero due to Federal Reserve control measures. But now interest rates are expected to hit record highs as the Federal Reserve tries to stem inflation. This means, I believe, that as the company’s debt increases, it will pay many more expenses this year compared to last year.
During the last reporting quarter, the company recorded an 8.12% increase in interest expense compared to the same period last year due to the increase in the federal funds rate from 0% to 0 .75% in 2 steps throughout the reporting period.
Given that the federal funds rate has since risen to 3%, I expect the company’s interest expense to be about 35% higher than last year, which potentially pay more than $3.5 billion for fiscal year 2022.
On the face of it, that’s not too bad, considering the company made around $100 billion in net profit last year. But then there’s the whole issue of sales growth, which worries me a bit more than last time.
Underperforming sales growth
There are a few factors that make it difficult for me to see Apple achieve the current sales growth projections.
The first is that they are far too dependent on telecommunications companies. These offer a free iPhone with a trade-in and some plan commitments, which is one of the main incentives people use to upgrade, since the new iPhone has little improvement over the one that preceded it, which was little improved over the one before. that and so on.
While there’s not much to make me believe the telcos will stop this incentive altogether, I think there’s a limit to how many cycles they’ll do as they focus on customer retention and not just on transfers or customer initiation. We’ve seen this with other incentives – they take place for a business cycle or two and then switch to offering other incumbent services. If, and it’s a big if, the iPhone 15 is to the iPhone 14 what the iPhone 14 is to the iPhone 13, I don’t think the reception will be as good without these incentives to give Apple millions and millions of sales.
This is somewhat confirmed by the reception of the phone in China. Sales of new iPhones have had a mixed reception in the company’s second-largest market, which it relies on for future sales growth, which doesn’t have as many free upgrade offers. This is due to the fact that individuals don’t want to spend all that money upgrading for upgrade’s sake as there is little improvement apart from the camera which is already pro grade.
With these 2 main factors, I just don’t see the business generating significant revenue for the next 2-3 years. The added fact that they are spending more and more on research and development every year with little results (so far) adds to this projection of underperformance on my part.
By the Numbers: Sales and EPS
The aforementioned factors lead me to believe that the company will likely underperform its current sales and EPS projections, leading them to be fairly to slightly overvalued. This in itself means that the company may be a poor investment choice, but more importantly that we are heading into a recession – the company’s shares may underperform the broader market during this period, which may be bad for Investors.
|Sales||$393 billion||$412 billion||$431 billion||$448 billion|
These figures not yet taking into account the already poor reception of the new iPhone in China, I believe that the aforementioned future overall underperformance means that the company will experience an average annual growth rate of less than 3% throughout the period 2025. .
In view of my previous comments,
1 – Increased sales due to telecom company incentives means lower gross margins.
2 – Higher interest expense, lower interest income, SG&A expenses and R&D expenses mean that the profit margin will be lower than in previous years.
3 – Lower-than-expected sales growth on higher-margin iPhones means margins will be lower.
I believe the company’s EPS growth rate will be lower than the sales growth rate. Here are the current projections for reference:
(Source: Seeking Alpha Earnings Projection Aggregator)
Comparing these EPS numbers with slightly lower overall sales and margin growth means that I believe the company is likely to report low single-digit EPS growth in the period to 2025 and is likely to signal, if all else remains the same, a negative EPS growth rate in 2025.
Conclusion – Avoid
The company, based on the aforementioned EPS projections, is trading at a futures price on an earnings multiple of between 21x and 25x over the period. It overvalues the company if its true growth rate is around 2-3% through 2025, in my opinion.
This means the company is likely slightly overvalued at current levels, and we shouldn’t expect it to make any significant gains in the stock price over the next 2-3 years. Since I believe this will be the case, I am moving my long bullish position on the company to neutral and I have been losing stock over the past few days and will continue to do so over the next few weeks.