Portfolio Spotlight - Apple Inc.

Apple Inc. (NASDAQ: AAPL)
Sector: Information Technology

Headquarters: Cupertino, California
CEO: Tim Cook


Executive Summary:


More than likely you are quite familiar with Apple Inc. (Apple) as their products are used by individuals and businesses across the globe. The goal of this report is to provide insight into the company’s past and the sustainability of its future. Hopefully you’ll learn something new along the way.
Apple Inc. (Apple) was founded in 1976 in Steve Jobs garage and has since then grown to be one of the largest companies on the planet in terms of market capitalization. The company has several products and services and has always differentiated itself by being at the forefront of innovation and design. By simply picking up an Apple product you can tell it’s a premium item. However, competition within the technology sector continues to increase. With many companies producing exceptional products and devices, research and development (R&D) and customer service are keys to maintaining market share and continuing expansion. Apple has created an slight economic moat for itself by developing seamless integration between its products. This provides some protection by elevating the switching costs for its customers that use multiple Apple products. In order to maintain and press this advantage Apple must continue to develop its ecosystem of products and services.


As you can see from the chart below, Apple has been an excellent investment this past year. The stock price is up 50.11% from 1/3/2017 to 12/21/2017.
 

Prices date sensitive - current as of 12/21/2017

 

Revenue Streams


Let’s take a look at Apple’s revenue growth, net sales by product, and its geographic streams. Net sales for 2017 increased 6% compared to 2016. This increase was “primarily driven by growth in Services, iPhone, and Mac.” – Form 10-K 
To understand the roots of Apple’s revenue, let’s take a look at the chart below. For simplicity, the pie chart is broken into the primary revenue drivers for the company.

 

Net Sales by Product – Fiscal Year 2017
 

 Data Source: Form 10-K


The following information is based on results from the 2017 Fiscal Year ended September 30, 2017.

 

iPhone | 62% of Net Sales


Net sales of the iPhone increased by 3% in 2017 compared to 2016. In September Apple released two new devices, the iPhone 8 and 8 Plus. Then in early November the company released the iPhone X with a hefty starting price of $999. This was a classic move by Apple, leveraging its brand and its ability to create hype around its newest products. Although seemingly an absurd price tag for a cell phone, it isn’t altogether unreasonable when you consider the cost increase to make an iPhone X as well as the features it delivers.

According to Tech Insights, a company that dissects a product’s parts to determine the cost, the price per unit (PPU) for the iPhone X is “25% more than the iPhone 8, but it retailed 43% higher” - Reuters
With a PPU of $357.50 and a gross margin of 64.21% the iPhone X should prove to be very profitable for Apple. Especially with the demand it’s seeing overseas in China. 
An RBC Capital Markets analyst by the name of Amit Daryanani talks about data collected from the iPhone market in China. “According to RBC Capital Market’s survey, 62% of the prospective iPhone buyers wanted to buy the latest and greatest iPhone X, which is much higher than 28% people in the US.” - Source citing that iPhone X is seeing “very strong demand in China”. This is good news for Apple as the iPhone has struggled to gain a strong foothold in China, especially with so many competitors undercutting them on price.


On a macroeconomic level, as interest rates in the U.S. rise, the U.S. Dollar (USD) appreciates against other currencies (all other factors held constant). This currency risk could be hedged with the use of futures contracts, however, the strengthening of the USD did have an adverse impact on net sales for 2017. Creating price points that reflect/anticipate the dollar appreciation is another method for mitigating this risk. The point of saying this is because the Fed has made every indication that rates will continue the gradual climb which could have the same adverse impacts on Apple’s sales made in foreign currencies. So keep that in mind in the coming year.


iPad | 8% of Net Sales


Net sales of iPad decreased by 7% in 2017 compared to 2016. This is the company’s line of multipurpose tablets. With the latest release in June 2017 of an updated 12.9-inch iPad Pro and a new 10.5-inch iPad Pro. This product isn’t nearly as widely used as the iPhone, however, it makes up an important piece of the Apple ecosystem I mentioned earlier. Part of Apple’s business strategy is “to bring the best user experience to its customers through its innovative hardware, software, and services.” – Form 10-K The uniformity and functionality between Apple’s devices is what creates that ‘ecosystem’ and user experience. All of Apple’s devices can sync with each other so as you switch between devices, you hardly notice the change. 
This comes into play when purchasing new products. I am a prime example of this myself, I have and will likely continue to purchase Apple products because of their functionality with the other Apple devices I already own. I hate to say it, but I rarely even consider other products when I am shopping.

Similar to the iPhone, iPad sales were negatively impacted by USD appreciation during 2017.

 

Mac | 11% of Net Sales


Net sales of Mac increased by 13% in 2017 compared to 2016. This increase is a result of 4% increased unit sales as well as a different product mix with higher selling prices. In October 2016 Apple introduced a new line of MacBook Pro’s and just a week ago Apple released the new iMac Pro. This is key for the success of any tech company. As I mentioned earlier, Apple has a fantastic brand, in fact it’s the most valuable brand in the world – Forbes But in the technology sector, brand will count for very little if other companies produce better and more innovative products. Especially with short product life cycles for smartphones – 1-3 years. Which is why Apple’s continuous release of new and improved products is a good indicator of strong results to come.


Services | 13% of Net Sales


Net sales from services increased by 23% in 2017 compared to 2016. This revenue comes from Digital Content and Services (music, movies, apps, etc.), iCloud, AppleCare, and Apple Pay.
This is an area where Apple intends to expand. With an announcement in August that the company will invest approximately $1 Billion in acquiring and producing original content. Source

 Just this week three content executives have left Amazon.com Inc. to join Apple. Source Among them is Tara Sorensen, the head of kids programming for Amazon.
The reason Apple is moving into this space is because of services like Netflix and Prime Video which take users away from purchasing or renting content from the iTunes store. This is a hugely competitive environment so it will be fascinating to follow and watch as Apple’s content takes shape.


Other Products | 6% of Net Sales


Other products include Accessories, Apple TV, Apple Watch, and iPod Touch.

The accessories complement all of Apple’s primary products and include things like Beats headphones, storage devices, the new AirPods, and HomePod (a wireless speaker).


Noteworthy is the Apple Watch Series 3 which has cellular capabilities. You can now make phone calls, send texts, and stream music without being connected to your phone. Additionally, Apple has teamed up with researchers from Stanford to create an app that tracks irregular heart rhythms. The app is called Apple Heart Study and is in the research stage of identifying if the Apple Watch can be used as a medical device for accelerating discovery of irregular heart rhythms. Source

It goes without saying, if this research brings to fruition the ability to catch irregular heart rhythms, it would become a must have for millions of patients and individuals across the globe. This would not only mean a huge opportunity for Apple Watch sales, but also would give Apple a foot into the $3.2 trillion health care market. 


Let’s take a quick look at the geography of Apple’s revenue.
 

Net Sales by Operating Segment – Fiscal Year 2017

Data Source: Form 10-K

 

I show this for two reasons. First, it’s valuable to see where in the world Apple’s sales come from and second, to show you the huge opportunity for expansion.

Competition is severe in the technology sector and iOS, the operating system for iPhone and iPad is dominated by Android in the United States.
iOS accounts for roughly 40% of the smartphone sales while Android accounts for roughly 60% of the sales. This means that Apple’s greatest revenue driver, the iPhone, has room to grow in terms of capturing market share. Being premium product with high prices, the iPhone isn’t for everyone so it’s unrealistic to expect a huge shift in the pattern of sales. However, the numbers do indicate an opportunity for growth.
As I mentioned earlier, analysts anticipate sales growth in China as a result of the new iPhone X and the increased memory on the phones.


Review


Hopefully this posting has provided some insight into Apple’s past and its future outlook. Some key points to take away and keep in mind:

 

  • Competition is fierce in the Technology Sector.

  • Apple’s brand and product ecosystem provide stability and pricing leverage.

  • New product releases are essential, even if they are small steps sometimes.

  • Keep on the lookout for the result of the heart study with Apple Watch.

  • Growth in China, a previous market struggle for Apple.

 

We hope this Portfolio Spotlight has provided some value to you.
Merry Christmas to you and your family!

 


*Please note that all financial data is date sensitive and is current as of today, December 22nd, 2017 or the date specified in each of the sources.
 
 
Authored by:  Jeffrey Gardner, Financial Advisor The information presented above has been prepared for informational purposes only and the commentary represent the opinions of the author and are subject to change at any time due to market or economic conditions or other factors. 
 

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