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Alpha Picks: Apple is not a value trap

Head of Equity Strategy / Saxo Bank
Denmark
  • Among our top 20 alpha picks in mega-caps, Apple is cheapest on EV/EBITDA
  • Continued strong revenue growth in 2015 raises questions about valuation
  • Is Apple a value trap? Our answer is No
  • Even if revenues were flat for next few years, the stock would still be attractive
  • Investors should not read too much into Apple's auto industry project
Apple store in Beijing
 Customers queue up to buy iPhones at an Apple store in Beijing. Photo: iStock


By Peter Garnry

Among our top 20 alpha picks in the mega cap segment (companies with a market value above $50 billion), Apple has the lowest valuation with a 12-month trailing EV/EBITDA at 6.3x which is around 50% below the S&P 500. 

High growth and low valuation

Apple's revenues grew 28% year-on-year in its fiscal year 2015 (ended in September), which left investors wondering how such a high-growth company can trade at such a low valuation. The intelligent investor should question whether Apple might be a value trap. 

In other words, does the low valuation accurately reflect the view that the future will be dim (zero growth and lower profits) and not a strong bull case? Or is the market is not properly valuing the company?

As the chart below shows, the share price has still not closed the drawdown that began around the second quarter of this year. Even though most analysts covering the stock are very bullish on Apple, that has not been enough to convince investors to bid up the shares.

Apple weekly share price since 2011
Apple share price
Source: Saxo Bank


Apple is not a value trap

Our view is that Apple is not a value trap as competitors have still not found a way to steal Apple customers away from its iPhone and other products. In fact, since the launch of the iPhone 6 the company has lifted its market share in key markets such as China and other Asian markets.

Even if we assume Apple would descend into zero growth for the next couple of years, the stock is still attractive. The current free cash flow to enterprise value is 13.5%, which is a very high and attractive yield for shareholders. In other words, with unchanged fundamentals, the company would paid back the current value in six years.

Unless we see a sharp deterioration in the underlying fundamentals over the coming quarters, Apple shares are still worth being long.

What will Apple's car project mean for the future?

The noise continues to increase around Apple's endeavour to enter the car industry. Rumours have it that Apple wants to go the way of Tesla Motors by producing a high-end electric car wired with Apple's software and potentially self-driven. However, the expected delivery date is as far out as 2019. So should we care about this in judging Apple's stock?

Our view is no. To make a meaningful impact on Apple's market value the car division would need to generate around $7 billion in annual free cash flow. However, most global carmakers have reported negative free cash flows in recent years, and even a car company such as BMW (also producing high-end cars) has managed to achieve free cash flows of around $7 billion only for two years (2008 and 2009).

Apple shareholders should not estimate the car project to be something more than what it is — namely a project. It might never fly.


— Edited by John Acher

Peter Garnry is head of equity strategy at Saxo Bank

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Alpha Picks - 2015-12-01

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