Apple: Not Too Late For Shareholders To Act


Investment Thesis

I am an avid believer that among large caps, Apple (AAPL) offers investors one of the best opportunities to profit. Furthermore, Apple does not need much in the way of growth to truly reward long-term shareholders.

Huge Cash Margin

I define a good business as being a business with a high free cash flow margin (defined as FCF/Revenue expressed as a percentage). I favor high free cash flow margin businesses, above 5% FCF margin, as these typically represent an ROE above 15%. Furthermore, given the choice, I prefer to work a little harder and seek out businesses with a FCF margin above 10%.

However, more often than not, when high FCF generating businesses present themselves, these businesses are nearly always trading at inflated multiples, leaving the bargain hunter without the necessary margin of safety for a rewarding investment. However, as can be seen in the table below, Apple certainly has a huge FCF margin.



Source: Author’s calculations

Furthermore, interestingly, in spite of Apple’s remarkable ability to transform each dollar of revenue into roughly $0.25 of free cash flow, Apple accomplishes this even after reinvesting back into its business – which is quite an astonishing accomplishment. Further, in the past 5 years, Apple has had a 5-year CAGR of roughly 8%. Once again, reinforcing the fact that not only is Apple a cash generating machine, its cash flows are also growing.

Financial Position

In my humble opinion, as an incessant bargain hunter, I believe that the market is under-appreciating Apple’s unrivaled war chest. Apple’s Q1 2018 results showed it having a net cash position of $163 billion – roughly speaking 20% of Apple’s market cap made up of cash. Furthermore, CFO Luca Maestri was resolute and unshakable on its earnings call that Apple would be a huge beneficiary of the recently enacted U.S. tax law, and that it would seek to repatriate its huge overseas cash.

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On the other hand, Maestri made it clear that the excess cash that Apple had was going to be deployed slowly over time. That the cash belongs to Apple’s patient and long-term investors, that Apple would not be returning the cash over a few swift years, with a special dividend or any such program.

We’re going to be very thoughtful and deliberate about [redeploying the cash]. Obviously, we want to make the right decisions in the best interest of our long-term shareholders.

Valuation

As I have already alluded to in the article, Apple is that rare beast that should not be available in a fully efficient market – yet here it is. If Seeking Alpha’s website is in any way representative of the market, it means that Apple is arguably one the most followed companies in the world. Yet, its full potential is in no way being priced in.



Firstly, as I have already discussed – roughly 20% of Apple’s current market cap is made of cash – thus, the metrics highlighted above do not fully do justice to Apple.

Secondly, Apple does not need much in the way of growth to deliver shareholders with a rewarding investment. In fact, even with close to nil growth, simply by keeping Apple’s top line steady and using some of its cash to repurchase its own shares, its shareholders will be rewarded.

Thirdly, Apple has numerous underappreciated opportunities for growth. Such as its newly found direction of moving away from being a hardware seller to an asset-light business model. Apple has of late migrated more towards a service business, which has started to show on its improved margins. And here is the thing, when I look at one the most valuable companies in the world, to think that it is still growing, I find this stupefying. But when I consider that there is still scope to improve on its FCF margins, then, I’m truly stumbled.

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Incidentally, if we bear in mind that Apple had to contend with a slightly shorter week in 2017 vs. 2016, then Apple’s overall Service segment was up 27% YoY to $8.5 billion – which says all there is to say about this newly found avenue for growth.

Investment Risks

It is important to remember that no matter how good an investment appears to be, there are always numerous risks, which have a tendency to surprise even the most cautious investor. Remember, John Templeton would always argue that the best analyst in the world was only right two out of three times. This means that no matter how much of a no-brainer investment Apple appears to be, we must also consider what the competition is doing and how the competition may disrupt Apple’s ecosystem.

Some of Apple’s competitors include Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), which is no easy pushover. As I have argued elsewhere on SA, Alphabet was slow to realize the mobile phone opportunity and allowed Apple to fully embrace and lead this market. However, I believe that Alphabet has learned from its past mistake and will do everything in its power to attempt to encroach on Apple’s Service business – through its Google Play shop.

Takeaway

The investment community is not being asked to pay for much to participate in Apple’s growth. In spite of it being wildly known that Apple has a huge amount of cash on its balance sheet, presently investors are favoring other companies, with the illusion of strong growth prospects, but in time, the investment community will be sure to regain common sense and appreciate real cash over revenue growth.

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Disclaimer: Please do your own due diligence to reach your own conclusions.

Note: The only favor I ask is that you click the “Follow” button, so I can grow my Seeking Alpha friendships and our Deep Value network. Please excuse any grammatical errors.



Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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