Shahid Jamil
Apple (NASDAQ:AAPL) has been one of the best and most solid investments for the better part of the past 20 years. As it released the iPhone in 2007, it began raking in amounts of money most other companies can only dream of and now they bring in billions from things like their Services segments, which is larger than some other companies bring in altogether.
But this past year there’s been a warning sign I was looking out for a long time – as they shed their cash reserves for share buybacks and other compensation, they’re losing their edge in the amount of investment and interest income they generate and now, for the very first time, they are paying more in interest expense than they’re bringing in.
This in and of itself isn’t all that bad considering they rake in about $100 billion in net income while paying just shy of $3 billion annually in interest expense. But with the lack of new innovative products, they’ve been relying more on telecom companies’ incentive to sell their new iPhone than organic excitement.
Let’s dive into the issues I see.
Debt Load & Interest Expense
Beginning in 2013, the company started taking on long-term and short-term debt while interest rates were near zero to finance their operations while conserving cash overseas and investing it to bring in interest, which more than covered the interest expense on the low-interest debt. Since then, the debt has ballooned from about $16 billion to just shy of $110 billion, which was down to about $95 billion as of their latest financial reporting.
But then the Federal Reserve started raising interest rates and the company began paying more in interest expense. After the repatriation holiday in 2017, Apple brought back a big amount of their overseas cash which was being invested and spent the vast majority of it for share buybacks and other shareholder-friendly activities, which lowered their interest income.
Even though, as I mentioned earlier, the company has reduced their debt from $110 billion to $95 billion, their interest expense for the same time period increased from $2.6 billion to $2.8 billion. Although these numbers pale in comparison to their income and revenue generation, it’s somewhat concerning in the long run given where interest rates are headed and the lower cash reserves the company has.
Cash, Investments and Interest Income
The company’s cash and equivalents and short-term investments have been rising for the longest time as the company accumulated cash, but over the past few years, the company announced that it intended at getting to a cash-neutral position and spending it to fund share buybacks and other shareholder-friendly activities.
Apple had more than $100 billion in cash and short-term investment in September 2017, which decreased to under $50 billion as of today.
The more interesting part of this is the company’s investments have been shrinking after the repatriation holiday back in 2017 allowed companies to bring back cash at record low tax rates, which were mostly used for share buybacks.
Apple had almost $200 billion of long-term investments in September 2017, which then slowly went down and hovers around $100 billion.
The Result: All About The Interest Rates
This resulted in the company’s interest income to fall as their interest expense is expected to continue and climb:
| 2017 | 2018 | 2019 | 2020 | 2021 | Current | |
| Expense | $2.32B | $3.24B | $3.58B | $2.87B | $2.65B | $2.78B |
| Income | $5.20B | $5.69B | $4.96B | $3.76B | $2.84B | $2.73B |
(Source: Company Income Statement Summary)
During the COVID-19 pandemic, interest rates went back to zero due to control measures by the Federal Reserve. But now, interest rates are expected to climb to records as the Federal Reserve tries to stem inflation. This means, I believe, that as the company’s debt load has been increasing, they will be paying a big chunk more in expenses this year relative to last.
In the most recent reporting quarter, the company saw an 8.12% increase in interest expense relative to the same period last year as a result of the federal funds rate increasing from 0% to 0.75% in 2 stages throughout their reporting time period.
Given the fact that the federal funds rate has increased to 3% since then, I expect the company’s interest expense to be higher by about 35% relative to last year, leading them to potentially pay over $3.5 billion for fiscal 2022.
On the face of it, this isn’t all that bad, considering the fact that the company made about $100 billion last year in net income. But then there’s the whole sales growth thing, which has me slightly more concerned than last time.
Sales Growth To Underperform
There are a few factors that make it hard for me to see Apple meeting the current sales growth projections.
The first is that they’re way too reliant on telecom companies. These offer a free iPhone with a trade-in and some plan commitments, which is one of the major incentives that folks use in order to upgrade since the new iPhone has little improvement over the one before it, which was little improved over the one before it and so on.
While there’s little to make me believe that telecom companies will stop this incentive altogether, I do think that there’s a limit to the amount of cycles they’ll do this as they shift to focus on customer retention and not only customer transfers or initiation. We’ve seen this with other incentives – they take place for a business cycle or two and then shift to offering other services in place. If, and it’s a big if, the iPhone 15 is to the iPhone 14 as the iPhone 14 is to the iPhone 13, I don’t think the reception will be as good without these incentives to give Apple millions and millions of sales.
This is somewhat confirmed by the reception the phone had in China. New iPhone sales had a lukewarm reception in the company’s second-largest market, where it’s relying on for future sales growth, which doesn’t have as many free upgrade offers. This is a result of individuals not wanting to spend all that money to upgrade for the sake of upgrading as there’s little improvement outside the camera, which is already pro-level quality.
With these 2 main factors, I just don’t see the company generating any meaningful revenues for the next 2-3 years. The added fact that they’re spending more and more on research & development each year with little to show for it (so far) is added to this underperformance projection by me.
By The Numbers: Sales & EPS
The aforementioned factors lead me to believe that the company will likely underperform their current sales and EPS projections, which leads to them being fairly to slightly overvalued. This on its own means that the company may constitute a poor investment choice, but especially since we may be heading into a recession – the company’s shares can underperform the broader market during that time period, which can be bad for investors.
| 2022 | 2023 | 2024 | 2025 | |
| Sales | $393B billion | $412 billion | $431 billion | $448 billion |
| Growth | +7.33% | +4.95% | +4.62% | +3.89% |
With these figures not yet accounting for the already-lackluster reception in China of the new iPhone, I believe that and the aforementioned overall future underperformance means that the company will be seeing a sub-3% average annual growth rate throughout the 2025 time period.
Given my earlier points about,
1 – Increased sales through telecom companies’ incentives means lower gross margins.
2 – Increased interest expense, lower interest income, SG&A expenses and R&D expenses means that the profit margin will be lower than in previous years.
3 – Lower than projected sales growth on the higher margin iPhones means margins will be lower.
I believe that the company’s EPS growth rate will be lower than sales growth rate. Here are the current projections for reference:
| 2022 | 2023 | 2024 | 2025 | |
| EPS | $6.10 | $6.46 | $6.84 | $6.96 |
| Growth | +8.81% | +5.87% | +5.83% | +1.71% |
(Source: Seeking Alpha Earnings Projection Aggregator)
Comparing these EPS figures to the growth in sales and slightly overall lower margins means that, I believe, the company is likely to report low single-digit EPS growth over the coming time period through 2025 and is likely to report, if all else remains the same, a negative EPS growth rate in 2025.
Conclusion – Avoiding
The company, based on the aforementioned EPS projections, is trading at a forward price to earnings multiple of between 21x to 25x over the time period. This is overvaluing the company if their true growth rate is around the 2% to 3% mark through 2025, in my opinion.
This means that the company is likely slightly overvalued at current levels, and we shouldn’t expect them to make any material gains in share price over the next 2-3 years. Since I believe this will be the case, I am shifting my bullish long-term stance on the company to a neutral one and have been shedding shares over the past few days and will continue to do so throughout the coming weeks.
