Apple Inc. (AAPL), one of the best-known companies of the modern era, has acquired a reputation for revolutionizing consumer technology in every area it steps into. Over the past few decades, it experienced several rises and falls before it released iTunes, a digital music store, in 2000. There was no turning back, and iTunes was followed by the iPod, a digital portable music player, which became a raging success with music junkies around the world.
The company has since expanded its offerings by introducing some of the world’s most popular mobile communication and computing devices, while personal computers, portable digital music players and related peripherals and software have remained a mainstay of its product portfolio. Apple’s product line-up now includes the iconic iPhone and iPads, which have proved its elixir of life, along with its traditional iPod and Mac devices.
Today, Apple generates most of its revenues from sales of the iPhone, its flagship smartphone which revolutionized the mobile devices industry. The iPad tablet is Apple’s second-highest revenue earner.
Over the past few years, sales growth in high-grossing regions has reached a saturation point. To counter this trend, Apple is trying to gain a stronger foothold in emerging markets, where low-priced Android phones have raced far ahead in terms of market share.
Sales in Greater China (grouped with other Asia-Pacific countries in the graph below) accounted for 14.9% of Apple’s revenues in 2013. This makes the country Apple’s third-most important geographic market by revenues.
For years, Apple has sought a deal with China Mobile Ltd. (CHL) to put its iPhones within the reach of the telecom giants’ more than 760 million subscribers. However, it was reluctant to reach a conclusive agreement because of the poor quality of China Mobile's network.
The two companies finally locked the deal in December 2013, and the world's largest telecom company will start offering iPhones to its subscribers starting January 17.
Apple also finalized a deal with Japan's largest carrier, NTT Docomo (DCM), last year.
Note: Asia-Pacific includes Australia, China, Hong Kong, Taiwan, and other Asian countries.
The iPhone is a line of premium-priced smartphones that run on Apple's proprietary software. The product, first introduced in 2007, proved to be a game changer in the smartphone industry with its intuitive, fluid and easy-to-use user interface.
The company broke with tradition in the product launch of its latest iPhones by offering two models at the same time. The mid-tier iPhone 5c, introduced with the premium-priced iPhone 5s, was introduced as a $100 cheaper alternative to the former. However, consumers did not respond too well to the ‘budget’ iPhone, and Apple has had to drastically cut production of the model in favor of the 5s, which has enjoyed stronger traction.
Annual iPhone sales have shot up from 1.4 million when they were first introduced, to 150.3 million in the recently-passed year. The company's deal with China Mobile alone is expected to add 16 million to annual sales in fiscal 2014 (FY14).
However, expectations are that iPhone production will be lower in the March quarter ever since a key components supplier cut its earnings guidance for that period.
Jabil Circuit (JBL), an electronic manufacturing solutions provider, has said it expects a 25% decline in revenues from its Diversified Manufacturing Services (DMS) segment. Apple accounts for half of Jabil's DMS revenues and nearly 19% of the firm’s overall sales, according to Citi estimates.
In Jabil’s February 2013 quarter, a 5% quarter-over-quarter (QoQ) decline in revenues from the DMS segment had corresponded with a 22% QoQ decline in iPhone shipments, and Jabil’s revised revenue guidance for the March 2014 quarter signals that Apple is likely cutting its production again.
Move to Emerging Markets
The average selling prices of consumer goods tend to be higher when companies sell their products mainly in developed markets, but decline as companies move to emerging markets where price points have to be lowered to cater to lower income consumers.
The proliferation of low-priced Android devices in emerging markets has eroded the demand for high-end phones, and this will put significant pressure on Apple’s margins as it shifts its focus to developing markets to stimulate growth. Samsung (SSNLF), Apple's biggest rival, has already been downgraded by analysts due to the uncertainty surrounding its future with prices for its products continuing to fall. At the same time, key competitor Google Inc (GOOG) is also cutting the prices of its Motorola smartphones (Moto X and Moto G) in order to make a strong headway in the market.
Apple’s gross margins have been declining since 2012, and will continue to decline as the company moves into emerging markets.
Apple's tablets include the iPad Air, the iPad Mini, and the discounted iPad 2. The iPad is Apple’s second-highest grossing product, generating 18.7% of its total revenues in 2013.
The iPad was a revolutionary product, and Apple recorded 330% growth in iPad sales within a year after it first started selling the device in 2010. However, Android tablets were the first to enter the seven-inch tablet market, which compelled Apple to introduce the iPad Mini in 2012 to compete with Google's Nexus 7 and Amazon's (AMZN) Kindle Fire.
The iPad’s average selling price has declined every year since the first one was launched in 2010; partly due to stiff competition, but mainly because of the lower price of the iPad Mini, which has outsold the regular iPad. According to Goldman Sachs (GS) estimates, Apple sold 38.6 million iPad Minis in 2013, compared to 32.3 million regular iPads.
Industry Overview and Growth Prospects
Apple is heavily dependent on the smartphone and tablet markets, which – though still growing – are set to mature soon. The company has entered newer markets to maximize its reach, but rivalries with local brands are intensifying as the latter offer better, yet lower-priced smartphones.
Apple may have introduced the iPhone 5c as a mid-tier brand, but it is still relatively expensive compared to mid-tier Android devices. According to Citi Research, a Chinese phone called the Xiaomi Mi3 is $75 cheaper than the iPhone 5c, but offers much better specifications. There are many other high-spec, low-price devices in the market which will also be competing with Apple’s premium-priced products.
The Year Ahead
In a recent memo to employees, Apple CEO Tim Cook said: "We have a lot to look forward to in 2014, including some big plans that we think customers are going to love."
It is widely rumored that Apple will be introducing a bigger iPhone this year in an effort to replicate the success of the Samsung Note, a tablet and smartphone hybrid known as a ‘phablet’.
Consumers can also expect a 12-inch tablet this year, which Apple hopes will replace smaller-sized notebooks in the market. Future Apple products will also likely feature some sort of gesture-based controls, as the company will be looking to 3D chip developer PrimeSense Ltd, which it acquired last year, to add further value to its products. Apple’s long-expected smart TV will probably be unveiled this year too.
Samsung introduced its Galaxy Gear smartwatch this year, which complements its Galaxy S4 smartphone. Apple is rumored to be working to introduce its own smartwatch, the iWatch, this year, which is expected to complement its other products. The company has hired the people behind Nike's (NKE) FuelBand, which signals that it wishes to make serious inroads in the wearable technology market.
Apple also introduced iTunes Radio last year, which will be a direct competitor to Pandora Media (P) and Spotify. It also bought analytics company Topsy. Both developments suggest that Apple is looking to monetize its user base through iAds.
Returns to Shareholders and Share Repurchases
Apple's $146 billion cash pile, of which $35.5 billion is parked in the US, has become a sore temptation for investors, who have increasingly pressurized the Apple management to initiate an accelerated share buyback on the grounds that the company is undervalued. Amid the tussle over how best those cash reserves can be utilized, the company has also started paying dividends to its investors.
Some analysts say Apple should forget the buyback and invest more in research and development (R&D) to rejuvenate its product line. The most recent generation of iPhones has been widely criticized as being a mere extension of the older versions and lacking innovation. However, a few activist investors have insisted that Apple has sufficient cash to invest in R&D, and that the company should return the rest to shareholders in the form of dividends and share buybacks.
Apple has paid out more than $2 billion in dividends every quarter, and its stock’s dividend yield is near 2.2%. The company paid out a total of more than $10 billion in dividends in FY13.
Additionally, it also repurchased more than $22 billion worth of shares in FY13, and the company expects to return $100 billion to shareholders by 2015.
Apple's dividend coverage ratio – a metric which evaluates a company's capability to pay dividends – has remained strong enough for the company to continue paying dividends in the future.
Stock Price Performance
Apple’s share price moved a mere 4% in 2013, even though the stock has soared 505% over the past five years. The company underperformed the Technology Select Sector SPDR ETF (XLK), which was up 22% for the year.
Valuation & Conclusion
With a big year ahead, we believe Apple will offer several new products to lure customers. Its new iPad Mini sold like hot cakes during the holiday season, and the company finally locked down a deal with the world’s largest carrier, China Mobile, which will boost its per share earnings by $3-5 in FY14.
Bidness Etc believes Apple’s products will continue to be at the forefront in consumer markets. The stock is currently trading at a price-to-earnings multiple (ex-cash) of 9.7x, which is quite inexpensive considering that it has traditionally been a high-growth tech company. With a dividend yield of 2.2% and an ongoing share repurchase program, the stock is a definite buy.