Apple is not like a purveyor of luxury handbags, jewelry or even dish soap, says analyst Toni Sacconaghi.
From a note to clients that landed on my desktop Thursday:
Following a rollercoaster 1H 2019, Apple has now climbed 43% from its trough in early January to trade at 17x consensus forward EPS, equivalent to its 5-year historical high. We generally hear two main arguments to justify this valuation: (1) that Apple’s stock should secularly re-rate to trade more like a high-end consumer brand; and (2) that Apple should be valued on a sum of the parts basis to reflect its growing Services business.
While we are constructive on the “consumer brand” thesis, we remind investors that Apple remains a fairly cyclical stock with over half of its revenues derived from a single mature product, the iPhone. Moreover, unlike luxury handbags, jewelry, or even dish soap, the iPhone is inherently subject to replacement cycle, commoditization, and disruption risk.
Our analysis suggests that a sum of the parts valuation does not necessarily point to material upside to Apple’s current valuation, either. While the company has done an excellent job of driving Services ARPU growth recently, even ascribing a 25-30x multiple to Apple’s Services earnings still requires one to believe that Apple’s standalone hardware business should trade at 12-15x earnings with no conglomerate discount – which is relatively generous compared with other hardware companies that are challenged to grow.
Could Apple nonetheless continue to outperform, despite its elevated valuation? It’s certainly possible. In the near-term, Apple’s recent outperformance likely reflects the investor belief that FY19 numbers have been “de-risked,” and we see little that might reverse this sentiment. Medium to long-term, the possibility exists that FY19 represents a near term “trough” in the iPhone business, at which point we could be approaching an inflection in hardware vs. services profitability mix (currently 69% / 31%), pointing to a modestly higher “sustainable” valuation over time. On net, however, we continue to believe the risk-reward on Apple remains neutral today.
Maintains Neutral rating and (underwater) $190 price target.
My take: Toni Sacconaghi is not a friend of the Apple investor.