Is Apple heading for a fall?
By
Phil Oakley Feb 05, 2013
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Bite into the iconic electronics brand and you’ll be left with a bitter aftertaste, says Phil Oakley.
The business
Apple is the world’s most famous consumer electronics brand, according to Forbes. It designs and makes computers (iMacs and Macbooks), smartphones (iPhones), music players (iPods) and tablet computers (iPads). It also sells digital media through its iTunes store and cloud computing services through iCloud, as well as designing and making computer operating systems and software. It has a network of 401 Apple retail stores across the world.
The history
Apple was formed in 1976 when Steve Wozniak and Steve Jobs began producing a micro computer in Jobs’s garage. During the late 1970s, the Apple II computer was initially popular with programmers, but subsequently became entrenched in the small business and education sectors. Its first Macintosh computer, launched in 1984, failed to meet sales targets and led to the ousting of Steve Jobs from the company.
Under CEO John Sculley, the Macintosh was improved and Apple gained a dominant position in the publishing and graphics markets. The 1990s saw Apple struggle against the dominance of Microsoft and the PC.
In 1997, Jobs returned to the company and began an amazing corporate turnaround with the introduction of products such as the iMac computer (1998), iPod music player (2001), iPhone (2007) and the iPad tablet computer (2010). Profits boomed and Apple become the world’s most valuable company.
However, the death of Steve Jobs in October 2011 has led some to question whether Apple has lost its creative spark. The company is still very healthy, but the lack of innovative new products and stiff competition from the likes of Samsung and Google have seen the company’s shares lose a lot of their appeal with investors in recent months.
The chief executive
Tim Cook became chief executive in 2011. He joined the company in 1998 after holding senior roles at Compaq and IBM. Having enjoyed the fruits of Steve Jobs’ strategy, Cook is now feeling the heat. He has a lot to do to convince people that Apple’s best days are ahead of it. If he can’t, he may be taking home a lot less than the $4.2m he was paid in 2012.
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Should you buy the shares?
The stock market’s love affair with Apple seems to be over. The first nine months of 2012 saw its shares soar from $400 to over $700 as investors bet on it continuing to sell more of its products at very high profit margins.
The company’s financial performance is, at first glance, an investor’s dream. Its profit margins are on another planet compared with other makers of consumer electronics. Not only that, but its assets are offset by a huge cash pile and financing from its suppliers. This means that its net investment in the business is very small and its returns very large.
But this is arguably Apple’s biggest problem – it is just too profitable for its own good. The competition is catching up fast and wants to take some of Apple’s profits for itself. Concerns that this might actually now be happening mean that the shares are now back to $450.
There are good reasons to worry. Take Apple’s iPhone as a case in point. The iPhone provides over half of Apple’s annual revenues and probably an even bigger chunk of its profits. Apple has been able to sell iPhones for around $640 each for the last two years. Consumers have bought these very expensive products because they thought they were buying the world’s best smartphone.
However, this is now questionable as more people plump for phones from the likes of Samsung, which can do a lot of the things an iPhone can do and cost less money. Apple wants to crack the Chinese smartphone market, but will have to slash its prices to do so because many Chinese consumers cannot afford iPhones. This is likely to see Apple’s profit margins come down a lot. We may already be seeing this happening with iPads.
Under pressure to make a cheaper tablet – the iPad Mini – iPads are now bringing in $467 per unit compared with $593 a year ago. We see the scope for Apple’s profit margins – currently 31% – to come down a lot. For example, Samsung’s smartphone and tablet computers business has operating margins of just under 19%.
Equally concerning is the lack of new products to wow consumers with. Apple’s success has been built on getting people to upgrade to the latest hot gadget. But the last two versions of the iPhone have been disappointing. Talk of an Apple TV set may simply be hype, given that smart TVs are already on the market. Unless it can rediscover its ability to innovate, it’s difficult to see how Apple’s profits can grow strongly.
Bulls point to its cheap valuation and £137bn of cash. The cash may be used to boost dividends to shareholders, but if profits fall sharply then the shares are no bargain today. That’s why we think anyone tempted to take a bite on Apple’s shares could be left with a bitter aftertaste.
Verdict: avoid
Share price: $450
Market cap: $422.6bn
Net assets (December 2012): $127.4bn
Net cash (December 2012): $137bn
P/e (current year estimate): 10.0 times
Yield (prospective): 2.4%
What the analysts say
Buy: 34
Hold: 10
Sell: 3
Average price target: $615
Directors' dealings
T Cook (CEO): 13,817
P Oppenheimer (FD): 4,793
A Levinson (chairman): 239,541
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