Apple Stock: You’ve Been Warned (NASDAQ:AAPL)

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Introduction and thesis

I have been covering Apple Inc. (NASDAQ: AAPL) in Seeking Alpha since mid-December 2021, when the stock was trading at $181. At that time, I considered that the action it was worth buying at the first 15-20% drop. At that point, given the still fairly low discount rate, we could get a fair value of around $194 per share. But with each new article, I became convinced that we were slipping lower and lower in understanding what the fair value of the business should be.

So in my second article, which came out after AAPL stock fell 16% following the publication of the first article, I suggested not to buy the stock drop, but to wait for another 15-17% drop before buying. At the time, my thesis provoked a mixed reaction: many did not understand why they should wait any longer to buy a quality company after such a decline. In my last article, published on September 30, I discussed a Bank of America stock research report in which I disagreed with analysts’ conclusions regarding Apple’s fair value calculation:

The only thing that confused me was the FY23/FY24 multiples that analysts use for their target price estimates.

Pay 25.5 times FY2023 net income and 19.4 times FY2023 EBITDA for a company whose volume is falling and whose prospects are likely bleak? No, thanks. This is well above the median of the last 10 years, suggesting that AAPL could fall many more basis points from where it is now.

Source: From my third article on AAPL [September 30]

Today, I want to warn all investors and dive buyers once again that it is still too early to buy AAPL stock in the current environment, no matter how much you believe in this company. Risks continue to mount, especially given recent developments at the Zhengzhou factory and the company’s still relatively high forward valuation multiples that do not yet factor in bleak prospects.

Why do I think like this?

Let’s first take a look at the latest news on what’s happening at the Zhengzhou facility, operated by Foxconn Technology Group. This facility is also known as iPhone City: it is Apple’s main production center for assembling Pro editions of its iPhones.

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Just a few hours ago, Bloomberg published an article Loudly titled “Apple Cuts Production of New iPhone by 3 Million Units as Demand Cools,” in which it releases some pretty interesting estimates of the impact of the Zhengzhou lockdown on prospective sales of the world’s largest company .

The Zhengzhou blockade is not unique to China. Unlike other countries, China still uses lockdowns to combat the coronavirus. For major industries, a “closed loop” is used, meaning that company employees live on campus near the production site and cannot leave the permitted area. In such conditions, that is, only working and sleeping near the plant, people are forced to live for several months, Bloomberg reports. But even these measures do not always help: at the Foxconn production complex in Zhengzhou, which specializes in the assembly of iPhones and is the largest in the world in its segment, a coronavirus epidemic began in late October.

In another itemBloomberg journalists recounted the story of a 20-year-old Foxconn worker who received no help from emergency services and even went without food were it not for the help of her colleagues. As a result, workers began to reject such conditions en masse and, due to the site’s limited connection to the outside world, must walk or take passing cars.

According to ivan lamSenior Analyst at Counterpoint, Apple can handle 100% of iPhone 14 and earlier orders through other locations in China, but only has a few much smaller locations qualified to handle iPhone Pro. As I mentioned in my last article, it was strong demand for the iPhone Pro that allowed the company to meet market expectations for last quarter’s results and outlook; now this income segment also suffers from the increasing risk of supply disruption. Apple has already lowered its forecasts for new device sales, but we’re now seeing the first signs that those lowered forecasts may be too optimistic.

Apple Inc. appears to be the last of the tech companies still holding up well in the current situation and, given its heavy weight in the indices, is supporting the entire market. I’m sure you’ve all seen the news that Apple now has a larger capitalization than Amazon (AMZN), Microsoft (MSFT), and Meta (META) combined:

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Twitter [@EconomyApp]

Twitter [@EconomyApp]

But has anyone seen how these market capitalizations correlate with the level of free cash flow generation of the selected companies?

Frame
Data by YGraphics

Amazon’s logistics issues definitely spoil the big picture. Yes, based on free cash flow (“FCF”) figures, Apple looks better than MSFT (EV/FCF multiple of 20.4x vs. 25.15x) but much worse than META (7.9x).

However, the fact that Apple is fair value in terms of free cash flow compared to other big tech companies is quickly negated when we look at companies in related or entirely different industries:

Twitter [@Quartr_App]

Twitter [@Quartr_App]

The only way to justify Apple’s valuation (based on this EV/FCF criteria) is the potential growth in FCF and ongoing buybacks, which have already totaled around $549 billion over the last 10 years (which charlie billello says is more than the market capitalization of 494 companies in the S&P 500 index).

But what if Apple’s gross margin had peaked, as it did in 1990 and 2012?

Alpha Chart Search, Author's Notes

Alpha Chart Search, Author’s Notes

What if Apple’s liquidity, which has been cut in half in recent quarters, at some point no longer flows into share buybacks, but instead redirects production from China to India?

Author's calculations, search for alpha data

Author’s calculations, search for alpha data

The last question is the one that worries me the most. Given the recent developments in China, it’s clear to me that Apple, and US companies in general, will be forced to look elsewhere for their manufacturing facilities; some of the production will return to the US, places with cheaper labor. It’s the relatively low labor costs that have helped Apple and other Western companies keep gross margins at the high levels we’ve grown accustomed to in recent years. However, relocation could not only incur one-time costs that impact FCF, but also affect the long-term level of gross margins, because it is not certain that a company in a new location will be able to pay China-level wages. .

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And the company is already having problems just with the relocation of production:

SA News

SA News

And now I challenge all Apple shareholders to ask themselves one question: Amid all these risks, are they willing to pay 22.1 times next year’s earnings?

And before you answer that question, take a look at the multiples the company was trading at just a few years ago, when problems like the current one weren’t even on the horizon:

Argus Research, Author's Notes

Argus Research, Author’s Notes

Analyst forecasts for the next two years imply a P/E of >20x in 2024, while EPS growth is expected to be 2.6% and 8.12% in 2023 and 2024, respectively. Why should we pay so much today for such modest operating growth tomorrow? As I noted in the table above from Argus Research, history looks back to 2017-2019 when the company had much higher EPS growth (and not only that) and roughly the same cash balance as today, but at the same time, the multiple Average P/E (in the mid range) was just 16.7x, which is 26.2% lower than today.

Bottom line

I remain neutral on Apple stock because, despite the obvious signs of a slowdown in business and high valuation multiples, the company continues to buy its shares on the market and has tremendous support not only from the retail investors but also institutional investors who are willing to buy any dip in the stock, even ones that make sense in terms of the actual data.

Does this mean that everyone should follow the crowd and buy these same dips?

I do not think so. There are companies in the market that are much more understandable in terms of their prospects that a) are still cheap, b) have a small following among investors and therefore are not as populous as big tech companies like Apple, and c) they will grow their EPS and not suffer a fall as in the case of the company that I analyze in this article. We have already described many of these companies in detail in my premium Invest beyond the wall service by including them in one of our model portfolios.

Thank you for reading!

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