Why Morgan Stanley raised its Apple price target to $232

Katy Huberty expects Apple to report an in-line June quarter and weaker-than-consensus September guidance, nevertheless she bumped her price target $18 (8.4%). Here’s why.

From a note to Morgan Stanley clients that landed in my inbox Tuesday:

Two months ago we introduced our SOTP-based price target frame work for Apple, where we value Apple’s Hardware/Device business (82% of FY19 revenue) using a blend of an HPQ and MSFT EV / Sales multiple, and the Services business (18% of FY19 revenue) using the median of 10 internet/services/platform [enterprise value] EV / Sales multiples.

With the average internet/platform comp up 16% since May 1 (and MSFT up 12%), we’ve seen a meaningful re-rating of peer multiples, which subsequently increases our SOTP-driven price target for Apple to $232, from $214 (Exhibit 12).

sum-of-the-parts

Click to enlarge. 

At $232, Apple trades at a 3.5x EV / 2019E Sales multiple and a 16.6x P/E on FY19E EPS, slightly less than one turn above Apple’s 10-year historical average P/E multiple of 15.8x.  However, with Services increasingly becoming a more important driver of both revenue and gross profit dollar growth (we estimate Services will account for 27% of Apple revenue and just under 40% of gross profit dollars by FY22), plus the fact that Apple has a larger and more accessible cash balance today, we believe this premium valuation is warranted. And as Services growth continues to stand out, we believe investors will begin to recognize this fundamental shift in company structure re-rating shares higher.

Maintains Overweight rating and raises price target to $232 from $214.

My take: If Huberty’s new method for valuing Apple seems somewhat arbitrary, it’s better than most of her peers, which seem completely arbitrary.

8 Comments

  1. Fred Stein said:
    I like Katy’s methodology. Most of her peers consistently show lower targets as a de-risking strategy, keeping AAPL undervalued by about 10% to 20%.

    2
    July 24, 2018
  2. Robert Paul Leitao said:
    We’re now seeing more Wall Street analysts willing to add a greater value on a per revenue dollar basis to Apple’s Services revenue segment relative to the value assigned to the company’s hardware revenue activity.

    Each day Apple is performing less as a hardware maker and more as the purveyor of the world’s best digital eco-system, inclusive of hardware, for enterprises and consumers. Katy Huberty has taken notice. It’s about time.

    Apple’s economic moat, driven by innovations in hardware and advancements in software and services, is widening. The Services revenue segment is reflective of growth on a global basis and its growth performance is indicative of the attractiveness of Apple’s product and services paradigm for enterprises, consumers, developers and content providers.

    5
    July 24, 2018
  3. Gregg_Thurman@me.com said:
    There was a time when I thought highly of Katy Huberty’s analysis. I give her an “A” for effort in trying to quantify Apple’s valuation, but only a C- for her results.

    You can’t compare Apple’s “hardware” sector” to that of HPQ or MSFT because they aren’t anywhere near equal.

    MSFT is a software company trying (successfully I might add) to diversify into services. Hardware is a minuscule part of its business and a very unsuccessful part at that.

    HPQ sells a lot of hardware, but that hardware comes in two parts: the razor and razor blade printer business (wherein HPQ gives away its printers in exchange for continuing ink cartridge revenue), and computers. Its computer business is mostly to the enterprise where a significant portion of the revenue comes from supporting that hardware and HPQ enterprise software, both of which can be construed as a service.

    Neither MSFT nor HPQ have a business model similar to APPLE’s so their EV multipliers are worthless as comparisons.

    Additionally, Apple generates gross margins on its hardware much greater than either MSFT or HPQ, not to mention free cash flow.

    I don’t know the firms Huberty compared Apple’s services segment with so I can’t speak to the quality of her observations, except to say her hardware comparisons were poor, so I imagine her services comparisons will be as well.

    Still, you have to commend Huberty for a price target that is currently the 3rd highest among 41 price targets issued by WS. If these are truly 12-month targets then they should all be ~10% higher.

    2
    July 24, 2018
    • Gregg_Thurman@me.com said:
      I forgot to point out that the manner in which Huberty separates hardware from services greatly discounts the symbiotic relationship shared by them. Hardware sales drive services revenue. Services drive hardware sales. One hand washes the other.

      Separating hardware and services undervalues hardware because it doesn’t consider the value services brings to the hardware and vice versa (walled garden), ergo the MSFT/HPQ EV multiple is even less relevant and understated.

      2
      July 24, 2018
  4. John Butt said:
    Gee these are great comments, but it would be even better for us as a group to re-do Katy’s analysis using the advice/comments included here. Hopefully someone has the time?

    0
    July 25, 2018

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