Does Apple’s growth rate support its valuation? Katy Huberty says yes

From a Q&A with Morgan Stanley clients that landed on my desktop Thursday:

What is our view on AAPL valuation relative to peers and relative to our view of long-term revenue growth? With the expected iPhone 12 launch fast approaching, investors are asking us how iPhone replacement cycles play into Apple’s growth profile going forward, and how that stacks up relative to other consumer and tech platform peers.

Our view: Apple deserves a platform multiple given its superior ecosystem of products and services that leads to high customer retention and repeat purchases. iPhone remains a core driver of Apple revenue (49%) and profits (44%). In recent years, iPhone replacement cycles elongated from 2.7 years in FY16 to an estimated 4.3 years currently (Exhibit 1) which offset strong installed base growth and translated to just 1% annual iPhone revenue growth from FY16 to FY19.

Despite this headwind, the strength of other products in the Apple ecosystem combined with significant share repurchases translated to 6% annual revenue growth and 15% annual EPS growth for the company over the same period.

But what if replacement cycles hadn’t elongated over this period? Assuming a flat iPhone replacement cycle translates to iPhone revenue growth and total Apple revenue growth of 14% annually over the same period (Exhibit 2), slightly ahead of consumer and technology platform peers (Exhibit 3).

Normalizing Apple’s historical growth for stable replacement cycles is a better predictor of future growth given we believe replacement cycles will at worst stabilize and at best shorten materially going forward, especially when considering iPhones are currently upgraded less often than PCs (Exhibit 1). We model iPhone replacement cycles shrinking to 3.7 years in FY21, from 4.3 years today and then stabilizing at 3.9 years longer-term, more in-line with PC replacement rates (which we still view as conservative).

Maintains Overweight rating and $130 price target.

Cue Exhibits 1-3 (click to enlarge):

Apple valuatiion Katy Huberty

Apple valuatiion Katy Huberty

Apple valuatiion Katy Huberty

My take: A return to a 3.9-year iPhone replacement cycle would be a big deal.

6 Comments

  1. Jerry Doyle said:
    Katy makes no mention of the Apple tailwind denoted by Cowen analyst Krish Sankar that the Dept. of Commerce’s restriction on US semiconductor sales to Chinese telecom & tech giant Huawei is disabling Huawei from selling as many smartphones for the near-term as it had planned initially. Huawei is seeing a significant decline. It does not seem that analysts have worked this mini thesis into current smartphone estimates. Sankar & team leave about 15-20M premium smartphones out of the equation for Huawei and up for market share grabs by other smartphone makers around the globe. No Apple analyst has considered this latest information in their calculations.

    In summary, Cowen & team think Apple & Samsung are well-positioned beneficiaries for more market share in premium segment with Xiamoi & others in the running for more share in the lower end of the market.

    0
    October 1, 2020
    • Gregg Thurman said:
      I’m not sure you can project higher iPhone unit sales due to Huawei’s inability to get crucial US made components.

      Try as it might to be a premium handset manufacturer Huawei is not. Lost Huawei sales are going to end up benefitting other non-Chinese Android manufacturers, not Apple.

      1
      October 1, 2020
  2. Jerry Doyle said:
    We are going to see Apple post some impressive iPhone revenues relative to expectation by most WS analysts. I also believe we are going to be impressed pleasantly, if not breathtakingly, by the mix of other hardware and accessory devices Apple moves in the coming quarters.

    1
    October 1, 2020
  3. Fred Stein said:
    Katy adds so much value, data and insight.

    IMO, the biggest driver of mulitple expansion is lower risk. Theoretically value is based on the DCF, where the Discount rate is risk adjusted. Apple by debunking the scary stories drops the Risk Adjusted Rate of Return, which dramatically increases the value of long term cash flows.

    2
    October 1, 2020
  4. Fred Stein said:
    Freakanomics: Using Katy’s data – thanks

    Apple’s replacement cycle normalizes to 3.9 years, while the SmartPhone market normalizes to 3.2. Given the weighting effect, the Android segment normalizes to about 3. That means iPhones last 33% longer on average, which in effect lowers the cost/month by 30%.

    1
    October 2, 2020

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