iPhone X - Hit or Miss?

After many years of owning an Android phone, I made the switch to Apple last year. Since then I've taken a keen interest in learning more about Apple, not just as the manufacturer of the "iPhone" but learning more about Apple as a company itself.

Yesterday marked the sale of the iPhone X, the most significant iPhone upgrade in the last few years. While some analysts are divided on how the iPhone X will perform and its impact on Apple's forthcoming holiday season earnings, I remain bullish on the company moving forward and below I discuss some reasons why. As per usual, I am no expert, this is purely my opinion from the facts/things I have read/watched recently.

Last night while watching the Bloomberg Technology podcast (great way to spend your Friday night isn't it?), I came across the graph below which indicates a 6.80% appreciation of Apple's share price in the last week.

Even with the ongoing supply chain issues and the several weeks of waiting time to get an iPhone X, in the short term, Apple's share price seems to be surging on the eve of its next-gen smartphone. However, as pointed out by Kevin Carter of Big Tree Capital:

"In the short term share prices follow sentiment, in the long term share prices follow earnings."

So is the spike in Apple's share price just positive short-term sentiment? I don't necessarily think so.

According to Bloomberg, Apple is poised to sell around 30-34 million iPhone X's in the next quarter but the iPhone X is just one catalyst in Apple's growth engine. As validly pointed out by Roger McNamee (founding partner of the venture capital firm Elevation Partners), the iPhone X will supplement the growing Apple "Ecosystem" and the benefits that come along with it.

One of the biggest questions going around is whether the iPhone 8 sales will cannibalise that of iPhone X and vice-versa. However, it's important to note that the technology advancement from the iPhone 7/7 Plus to iPhone X is greater than the leap from 7/7 Plus to the iPhone 8/8 Plus. This creates a segmented market, firstly those on the hunt to replace their iPhone (after 20 - 24 months of owning the older model) and those Apple fans who will pay top dollar year in and year out to own the latest iPhone. The latter of the two will definitely opt to buy the iPhone X whereas the first market is more unpredictable.

For example, for an iPhone user who now wants to upgrade from their iPhone 4, 5 or 6 to a new model simply have more options than they did before (compared to when the initial iPhones were launched). With the announcement and arrival of the new iPhone models, the iPhone 7, iPhone 7 Plus, iPhone 6s, iPhone 6s Plus, and iPhone SE have all received healthy discounts while still providing the "Apple Experience". This sees multiple iPhone products on the market at the same time, meaning people have access to a broader range of iPhones depending on their willingness to spend and budgets. Furthermore, having produced the older versions of the iPhone for several quarters/years, Apple has been able to streamline the supply chain and achieve economies of scale in relation to its older product line, meaning healthy margins even when discounts are applied.

Focussing on the iPhone X, it appears to be a hit so far (demand appears to be far greater than supply - good problem to have, at least in the short term) and essentially will help to drive more people into the "Apple Ecosystem" which will continue to strengthen Apple's position moving forward.

The Apple Ecosystem

So what's the Apple Ecosystem? It's pretty much a situation where a consumer owns an iPhone, Apple Watch, Macbook, has bought multiple iOS Apps and uses Apple Music. The interlinking between these components adds to the "Apple Experience" as such creates brand loyalty towards Apple while also creating high switching costs - Imagine buying the Android equivalent of the apps you have already paid on iOS! Comments around the "Apple Ecosystem" is further strengthed by Warren Buffett's view on Apple as summarised by Gary Mishuris, Managing Partner, Chief Investment Officer at Silver Ring Value Partners:

"The reasons Warren Buffett gave for buying Apple:

He believes it's really not a technology company, but a consumer company.

This is based on the company's brand and eco-system.

The latter creates a loyal community of users with high switching cost, where even if they might prefer some individual non-Apple device better, the ecosystem (iTunes, apps, etc.) keeps them with Apple.

The former is because people love Apple's aesthetics, ease of use, etc., rather than purchasing it because of some vastly superior technological advantage."

Recent Earnings At A Glance

With individuals (mostly Millenials) willing to spend over $1000 AUD on an iPhone X while struggling to move into the housing market indicates the inelastic demand curve for Apple products, even with its new products being released at a greater price point than previously. Apple's earnings release for Q4 reported earnings above market expectations with Apple selling a few more iPhones than expected but making more money (complemented by other products in the Apple Ecosystem other than iPhones) as summarised below:

• Q4 adjusted EPS: $2.07 vs. $1.87 expected by a Thomson Reuters consensus estimate
• Q4 revenue: $52.6 billion vs. $50.7 billion expected by Thomson Reuters
• Q4 iPhone unit sales: 46.7 million vs. 46 million expected by a FactSet consensus estimate

The Future Outlook

Recently, I came across a post by Jason Teh from Vertium Asset Management who discussed the topic of a stock market bubble. However, a particular graph that caught my attention was the PE Multiples (next 12 months) of the largest US Tech stocks (below).

Before I continue, a bit of background on the P/E ratio. The P/E ratio (otherwise known as the Price to Earnings ratio) looks at the company's Share Price v the Earnings per Share. I've included a brief extract on the P/E below from Investopedia which summaries the whole concept in a clean and simple manner.

"In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. This is why the P/E is sometimes referred to as the multiple because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends."

Looking at the major tech stocks, as seen from the graph above, Apple has one of the lowest P/E ratios. Why could this be the case and if so, is Apple undervalued?

A potential contributing factor could be the rate at which Apple's revenue has grown annually. The graph below indicates the annual revenue growth % for Apple v Amazon over the last five years and highlights why Amazon's greater revenue growth % warrants a higher P/E ratio along with a higher share price.

Furthermore, Apple experienced its first annual sales decline in 15 years in 2016, causing the market expectations around Apple being a growth stock to shift. This is why the success of iPhone X is particularly important, to signal to the market that Apple can continue to be a growth stock and continue to push its revenue growth % further.

Is Apple undervalued? Possibly. As highlighted earlier, Apple's share price has been increasing since the announcement of iPhone 8/ iPhone X and the next earnings season will paint a better picture of how consumers react to Apple's most recent mega expensive phones! I was particularly intrigued by comments made by Anil Doradla (SR Analyst at William Blair) on CNBC. He mentioned looking at the bigger picture revealed that there is no competition even when Android Phones collectively outnumber iPhones. He pointed out Pixel Phones as another Google "Science Project" with Pixel being one of just the many so far (he has a point) while Samsung is trying to cater for both the high and low end of the market, where the low end is being targeted by Chinese Manufacturers (such has Xioami) and the high end is being targeted by Apple.

In conclusion, I believe Apple has plenty of room to grow, particularly as a "Consumer Company" rather than just a "Technology Company" with the iPhone X being just the next component of it's ever-expanding Apple Ecosystem and loyal customer base.

What are your thoughts? Leave comments below!