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Apple (NASDAQ:AAPL) rang into the New Year with a boom by becoming the first U.S.-listed public company to surpass a market cap of $3 trillion. But the stock, alongside the broader market, has since come to a bust with declines of more than 15%.
With inflation running its hottest course in four decades, the Federal Reserve has showed signs of amped-up urgency in paring pandemic-era stimulus and pivoting toward a hawkish stance on monetary policy tightening. The impending rate hike cycle that is expected to begin in March has stirred investors’ concern over potential erosion of value on future gains and stalled growth due to rising costs of capital. This has led to a broad market sell-off in recent weeks, especially for high-growth stocks, as investors rotated out of risky assets to safer investments like Treasuries. As benchmark Treasury yield surpassed 1.8% last week in anticipation of the Fed’s plans to begin the rate hiking cycle soon to quell runaway inflation, the tech-heavy Nasdaq 100 was pushed into correction territory after declining more than 10% from its November closing record. A disappointing outlook released by Netflix (NASDAQ:NFLX) last week also has further fuelled investor angst, as the market continues on a freefall despite the brief mid-day rebound observed on Monday’s session.
Apple stock is now standing in a unique position in terms of timing, with Fed Chair Jerome Powell to give an update on monetary policy decision on Wednesday and the tech giant’s corporate earnings release on Thursday. On one hand, Wednesday’s briefing from Powell could lead to further market volatility as investors brace for an announcement on the timing and magnitude of upcoming rate hikes. On the other hand, Apple’s results and outlook to be released on the following day could come in strong and save the day by reversing the dire sentiment over the technology sector.
While some are bracing for an aggressive dose of monetary policy tightening with an initial rate hike of up to 50 bps in March to rein in inflation, the Fed will likely tread lightly over the matter. Despite historical inflation, it’s likely the Fed is “acutely aware of the risk around getting too aggressive” and making a policy mistake that could be detrimental to the economy. As for Apple, the tech giant is expected to deliver an update that will likely encompass strong holiday season sales and robust demand for its products and services, despite protracted supply chain constraints being the near-term overhang.
As discussed in our previous coverage, Apple remains a top hedge against mounting macro headwinds like inflation and rate hikes. With strong cash flows, robust earnings and revenue growth, and expanding margins through scale and pricing power, the performance of Apple’s underlying business is really as good as it gets when it comes to resistance against inflation and tightening monetary policy. The stock’s latest pullback also puts its current trading multiples at a small discount compared to those during last year’s February tech stock sell-off. It’s currently trading at about 28.8x TTM earnings compared to above 30x at the onset of 2021’s early-year sell-off.
Apple’s demonstration of continued strength in demand for its products and services, its ability to generate robust cash flows, and its innovative technology roadmap builds a strong hedge case against upcoming valuation adjustment risks posed by the upcoming tightening of monetary policy. Paired with the stock’s recent pullback in price, we’re maintaining a buy rating with expectations for it to contest the $200-level within the next 12 months.
What We have Observed So Far Over the Holiday Season
Following last quarter’s earnings call when the company reported $6 billion in lost sales due to COVID- and supply-chain-related disruptions, there have been growing uncertainties on how the biggest sales quarter of the year has fared in one of the most protracted supply chain disruptions experienced in the history of the industry. We have done some field work over the holidays and earlier this month by going to Apple stores to gauge how sales have performed during the December quarter. Based on discussions with sales representatives, this is what we have gathered:
- Black Friday: Apple has opted for gift card rebates over traditional discounts on sticker prices offered by authorized retailers during the Black Friday shopping event. Based on discussions with in-store employees, the strategy has done a good job in retaining sales from customers who would have otherwise left the store empty handed due to lack of inventory on products they had originally intended to buy. For instance, bundle rebates on lower-priced in-stock items like the AirPods and AirTags have garnered strong traction during the annual shopping event. In our view, the gift card rebate has not only proven to be a prudent strategy in retaining customer sales despite lacking inventory, but also a good way to ensure additional inflow of future revenues instead of one-off discounts for customers that could be lost to competitors down the road.
- Boxing Day: Visited Apple stores in North America actually did not offer any Boxing Day discounts, but demand for products remained robust. Many customers came in looking for the new iPhone 13 and iPads, but were forced to leave empty-handed due to severely limited inventory levels. Most had opted for online orders, which had long wait times, but that has not deterred them from making the purchase. This implies stickiness of demand for Apple’s suite of products, as well as the effectiveness of Apple’s continued commitment to product upgrades and innovations.
- Today: Visited stores said they have quickly sold out of stock received on the all-new MacBook Pros, which run on the M1 Pro/M1 Pro Max chips. However, customer demand remains robust with many turning to online orders despite a three-week minimum wait time. Many stores are also out of all models of the iPads. On the iPhone front, some stores have indicated they had just received shipment for what was supposed to be December stock. Many salespersons we have spoken to believe sales would have been much better had the iPhone 13 shipments arrived in December as intended because that was pretty much what everyone was asking for during the holiday season. On the downside, this implies Apple has certainly remained impacted from supply chain bottlenecks during the holiday season. But on the upside, the iPhone 13 clearly remains a dominant player in the smartphone, and 5G-enabled devices, market.
Supply chain constraints are clearly still a theme for Apple. And it seemed to have been accentuated over the December-quarter – its best sales quarter of the year – when most wanted to get their hands on the most advanced mobile and computing devices, and complementing accessories and gadgets. Yet, the company continues to be prudent in salvaging sales through strategies like gift card rebates to abate the impact of lost sales from supply chain disruptions, which we consider a prudent move to ensure demand does not spill over to competitors. Consumer willingness to endure long wait times through online orders are also testament to continued strength in demand for Apple’s products.
A high-level conclusion based on the information gathered from stores visited would imply the company has likely endured much more than $6 billion in lost revenues due to ongoing COVID- and supply-chain-related impacts to business during the December-quarter. However, demand definitely remains robust, which underscores the tech giant’s continued dominance across the market segments in which it operates in. And the company’s management team has clearly done a good job in ensuring demand remains in their pockets despite the current shortfall in supply. These, together, are all positive signs that the company’s valuation prospects remain intact.
Easing Supply Chain Constraints
On the supply front, supply chain bottlenecks are expected to ease over the course of the current year, which will help the stock defy related pressures as well as those from the recent sell-off on rate hike concerns. Following Microsoft’s (NASDAQ:MSFT) most recent earnings call Tuesday, the stock saw a steep rebound following announcement of a strong outlook on cloud-computing business growth. And a similar trend should be in order for Apple as well, considering expectations for a positive change in management’s sentiment towards the current supply chain situation which would imply a strong performance outlook for the year.
The expectation is further corroborated by recent information released by Apple’s key supply chain partners, including Texas Instruments (NASDAQ:TXN) and Hon Hai Precision Industry (OTCPK:HNHAF). Texas Instruments, the world’s largest producer and supplier of analog and embedded processing chips, and a key supplier of display parts to Apple, has provided a stronger-than-expected sales and profit forecast during Tuesday’s earnings call. The semiconductor giant also reported slight improvements to inventory levels, albeit still about 40% lower than normal, as well as lower volumes of expedited order requests. These items, together, suggest that the ongoing chip supply shortage may be finally starting to ease. The expected trend is further corroborated by recent announcements from Hon Hai Precision Industry, the key assembler of Apple’s iPhones. Hon Hai’s Chairman Young Liu is predicting “unprecedented performance in the first quarter” that will surpass historical output levels. The global leader in contracted consumer electronics manufacturing is gearing up to ensure adequate levels of inventory for customers this quarter, including Apple, to prevent further unravelling of supply chain disruptions.
While Apple’s fiscal second quarter has historically experienced slower sales compared to the fiscal first quarter due to seasonality, recent improvements to supply chain will likely drive a boost in sales. Paired with in-store observations of replenished iPhone stock and the expectation for returning customers looking to cash in their gift card rebates received over the holidays, a stronger-than-expected outlook for the year is likely in order.
Continued Demand Buoyed by an Ever-Improving Product Line-Up
The iPhone 13 remains the dominant 5G-enabled mobile device on the market. It was the most sought-after product during the holiday season, and remains so today even as inventories begin to return to normal levels. Some regions are reporting wait times of up to a full week for online iPhone 13 orders to arrive due to the ongoing clash between robust demand and squeezed supply. While Apple is in process of restoring balance across its supply of the iPhone 13, its core revenue driver among other products, it is also continuously working on improving its product roadmap.
This includes the highly anticipated roll-out of the budget-friendly 5G-enabled iPhone SE, which is expected for later this year. The current iPhone SE only supports up to 4G LTE, and is still running on the 2019 A13 chips, while the newest generation of iPhones have already moved on to the A15 Bionic chips which promise much faster speeds. Although Apple has not yet released any official statement on the potentially newest addition to the iPhone family, it would only make sense for an upgrade on the iPhone SE with 5G and new processors to ensure its performance is caught up to current demands. As mentioned in our previous coverage, iPhone sales are expected to remain robust in coming years as global 5G device upgrades continue to gather pace. And the launch of a more affordable 5G-enabled iPhone SE would better equip Apple to attract switchers from “more than a billion non-premium Android users” and further its market share in the smartphones category. It would also help Apple maintain its lead in the 5G competition against rival Samsung, which has recently launched its own budget-friendly Samsung Galaxy S21 FE 5G to capitalize on rising opportunities stemming from non-premium upgrades.
The global push for 5G adoption and Apple’s aging installed base of iPhones is also expected to drive the segment into one of the largest multi-year upgrade cycles ahead. Reputable wireless carriers have been keen on promoting the sale of 5G-enabled devices, including the iPhone 12/13, in recent months with enticing offers in hopes of boosting their 5G network sign-ups to recoup their years of investments into the rollout of next-generation wireless service. And with more than a quarter of Apple’s active iPhone installed base being older than 3.5 years (circa iPhone 8 and iPhone X), Apple is looking to benefit from a multi-year wave of upgrade purchases as users of the older iPhones look to convert to newer models that are compatible with the latest technology.
As mentioned in earlier sections, Macs and iPads also appear to be rare commodities right now due to stickier-than-expected demand that have carried over from the peak of the pandemic. Robust holiday season demand for iPads, iMacs and MacBooks observed in store and online have driven the segment’s shipments up by 9% compared to the prior year, beating performance of all five best-selling PC vendors. While the milestone is expected to be a plus for fiscal first quarter earnings to be released later this week, the anticipated launch of additional product upgrades across Apple’s computing devices segment is what will drive further acceleration in growth for the current year and beyond:
- iPad Pro: The last time the iPad Pro had a full-on makeover was in 2018, which made its debut about a year and a half after the preceding model. Taking that for a proxy, a completely redesigned iPad Pro should be in the books for launch later this year, especially as the last two models were essentially “new chip and camera upgrades.” In addition to an exterior makeover that would likely feature a glass back, the next-generation iPad Pro is expected to be equipped with the newest M2 chip and integrated wireless charging to match capabilities of the iPhone.
- iMac: With the newest M1 Pro and M1 Pro Max chips now fitted into the redesigned MacBook Pros, the next step would likely be to bring them into the iMac desktops. The redesigned M1-powered iMac launched last year has proven to be in high demand thanks to the surge in global demand for reliable workstations for work-from-home needs. Any improvements to the desktop’s processing power will likely drive further demand from those who has yet to make the leap on an upgrade, especially as the rising tide of hybrid working and learning arrangements is proving to be a staying trend even in the post-pandemic era.
Services are also expected to play a larger role in Apple’s growth trajectory going forward. About a quarter of Apple’s sales last year were attributable to the services segment. Yet, it only accounted for about 10% of Apple’s consolidated cost of sales, indicating the segment’s generous margins. And Apple’s bottom line will only further benefit from expectations for further growth in demand for Apple services going forward. To date, Apple has garnered more than 745 million paid subscribers across its high-margin service offerings, representing a five-fold increase over the last five years. And its recent push for a subscription-based business model across its wide array of existing service platforms, ranging from Apple Music to iCloud storage solutions, paired with attractive new offerings and pricing options will continue to be a key driver for the segment’s growth, and inadvertently, the company’s fast-expanding margins.
Conclusion: AAPL’s Pullback Is a Buy Opportunity
Although equities are likely to remain volatile in the near term due to uncertainties over the timing and magnitude of the Fed’s monetary policy tightening agenda, Apple will likely draw a rebound from Thursday’s earnings call. While lost revenues driven by COVID- and supply-chain-related disruptions are likely a given, the tech giant is expected to have set a new record for fiscal first quarter sales on strong holiday season demand, nonetheless. Recent observations of easing supply chain constraints across Apple’s suppliers and manufacturing partners also signal improvements to the current year sales outlook, which bolsters investors’ confidence in the stock. And the continued strength in demand for Apple’s products and services will likely maintain the brand’s pricing power to beat any persisting inflation pressures ahead.
As discussed in detail in our last coverage on the stock, Apple’s overall valuation prospects remain intact despite the impending rate hiking cycle. Robust global demand for Apple’s offerings as discussed in the foregoing analysis are expected to further grow Apple’s cheque book, making a strong tailwind against downward valuation pressures stemming from upcoming changes to the macro environment. We believe there’s still a massive runway for the stock to grow in both the near and longer term, which makes its recent pullback in price a reasonable buy opportunity.
