Author | JR Research
Translate | U.S. Stock Research Agency
Apple Inc., Inc. (AAPL) has recently attracted a great deal of interest from investors, as the stock has outperformed the market since early December. Notably, AAPL has lagged behind the broader market almost all year round. However, with the successful launch of a range of new products, including its key iPhone 13, investor interest has surged.
Supply chain checks from numerous sell-side analysts also show that the latency of Apple's phones has improved significantly. In addition, Goldman Sachs also stressed that the delivery cycle in mid-December was significantly shortened as Apple continued to take advantage of strong iPhone demand in the most critical calendar quarter.
Apple continues to hold steady prices, just below the potential $3 trillion market cap milestone. However, there is no doubt that AAPL has maintained a clear long-term upward trend over the years. In addition, given that the company has multiple long-term drivers of its business model, we are confident that the stock will reach $200 in 2022.
As we look ahead to the $3 trillion market cap in 2022, we discuss these key drivers of AAPL stock.
Service revenue growth can be grossly underestimated
Both Apple's revenue and adjusted EBITDA were aligned expectations. Source: S&P Capital IQ
Apple bears often point out that the slowdown in the company's revenue growth proves that a stock is grossly overvalued. It's easy to understand what they mean. Readers can refer to the chart above, where Apple's revenue growth is expected to decelerate over the next three years. Consistent estimates show that revenue is growing at a CAGR of just 4.6% as of fiscal 2024. In addition, its adjusted EBITDA margin is likely to remain unchanged. However, AAPL is not expected to gain profit leverage. As a result, bearish investors claim that they don't understand how Cupertino continues to justify its current valuation.
However, we believe investors need to take a step back and consider the key growth drivers for AAPL to move forward. Let's take a look at our analysis.
Apple iPhone and service revenue estimates. Source: Trefis, author
Readers can refer to the model above, in which the compound annual growth rate of iPhone revenue is expected to be only 2.2% over the next five years. However, Apple's services divisions, which include the App Store's revenue, are expected to increase their revenues at a compound annual growth rate of $116 in fiscal year 26 to $115 billion. We believe these estimates are relatively conservative. Based on these estimates, the implied fair value of SOTP in AAPL shares amounts to $159. It also includes other segments, but is primarily driven by the two key segments mentioned above. The iPhone and the service account for 43 percent and 25 percent of its SOTP valuation, respectively.
However, we think these estimates may not have captured the multiple growth drivers that underpin the App Store. Why?
According to Sensor Tower's recent estimates, App Store revenue will grow at a compound annual growth rate of 20.7 percent to $185 billion in the 25th quarter of this year. Notably, this far exceeds the $115 billion estimate for the entire services space we discussed earlier. Importantly, apart from the Contributions from the App Store, we don't even include revenue from other services. Therefore, we think readers need to consider that the Wall Street consensus may significantly underestimate the strength of Apple's highly profitable (estimated operating margin > 70%).
We're not saying that Sensor Tower's estimates are the source of the facts. However, we want to emphasize that investors should pay more attention to Apple's key service areas. Sensor Tower provides a breakdown of data by region, which we think seems to be interesting.
Don't ignore Apple's meta-cosmic ambitions
Guo Mingxi, an analyst at Tianfeng International Securities, estimates that Apple's AR/VR devices will be released sometime in the fourth quarter of 2022. We think this is significant because it heralds Apple's ambitions to march into the metaverse. There is no doubt that Meta Platforms (FB) and Microsoft (MSFT) are strengthening their leading position in consumer and business augmented AR/VR. According to TrendForce, global AR/VR device shipments are expected to reach 12.02 million units, up 26.4% year-on-year in 2022. In addition, the market is expected to grow rapidly in 2025, reaching 25.76 million, with a compound annual growth rate of 38.8%. Notably, it expects Meta's Oculus devices to maintain a 66 percent consumer market share. However, TrendForce also states:
Augmented AR/VR equipment vendors may seek to expand their user base and increase their market penetration with low-cost but high-spec devices, while compensating for the decline in the profitability of their hardware through software sales. (Trend Force)
It is indeed a software sale. Apple operates the world's largest mobile ecosystem, dwarfing Google Play's revenue. As a result, we believe Apple's entry into metaverse games could significantly improve the company's monetization opportunities. Theories abound about Meta Platforms' ambition to replace Apple as the next generation of computing platforms. However, we also discussed that the ultimate metaverse of Meta Platforms is unlikely to be the only virtual world we have experienced. Instead, the metacosm is likely to be a series of interconnected virtual worlds that can be interoperable. As a result, Apple may remain a key ecosystem owner, as developers can create their own virtual worlds through the App Store and gain access to Apple's more than 1 billion (and growing) install base.
TrendForce also added that by 2025, global VR content revenue is expected to grow rapidly at a compound annual growth rate of 40%, reaching $8.3 billion. The content will vary, but will mostly consist of "gaming/entertainment, video, and social interactions." As a result, Apple can continue to take advantage of these opportunities through its vast ecosystem. We think these opportunities are so novel that it hasn't even been written into Apple's consensus estimates. However, once Apple's AR/VR devices are launched, we believe the revenue podio could become more pronounced. However, we must still warn that we are still in the early stages of Apple's metaversonic ambitions. However, we believe Apple will be a key player in defining the metaverse through its ecosystem. Considering that Apple does not have a clear metacosmic strategy, it is not wise.
So, is AAPL buying now?
AAPL equity EV/NTM EBIT and standardized price-to-earnings (NTM) 3Y mean.
If you consider the relative valuation of AAPL stock relative to its 3Y mean, there's no doubt that AAPL seems expensive. Its EV/NTM EBIT is 26 times, well above its 3Y average of 19.3 times. In addition, its standardized price-to-earnings ratio (NTM) is also 31.2 times, which is much higher than its 3Y average of 23.9 times. So we won't blame bearish investors who believe AAPL stock now seems to be overvalued.
Apple does not include FCF estimates. Source: S&P Capital IQ, author
However, we also estimate that AAPL will continue to generate strong FCF growth over time. In addition, our model is even more conservative than consensus estimates. Nor did we consider the Sensor Tower estimates we discussed earlier or Apple's metacosmic chances. Still, it leads us to a $153 DCF implied fair value valuation. That's also very close to the $159 SOTP implied fair value we showed earlier. So, it's clear that these estimates don't take into account the strong growth in services and the potential metacosm opportunities apple could get in the next five to ten years.
AAPL share price movements
Still, we think AAPL stocks look extended, as shown in the chart above. But, as mentioned earlier, investors bet on CEO Tim Cook & Co. not too wisely. A long-term upward trend in the stock can be observed by all.
As a result, it's clear to us that with the growing excitement surrounding its AR/VR launch, coupled with the growth in services segment revenue in its earnings releases, the stock is likely to break above the $200 level in 2022. As a result, we believe AAPL's share price could be re-rated to reflect its potential for the coming year.
However, due to its excessively prolonged price action, we encourage patience with AAPL. However, if you don't have AAPL stock, if you're a long-term investor, we think you could consider adding to your position at that price. As discussed earlier, we don't think it's grossly overrated. However, if you already have considerable exposure relative to your portfolio, we think you can be patient and wait for a potentially better entry point.
Therefore, we reiterate our current neutral rating of AAPL shares.