Apple Stock: You’ve Been Warned (NASDAQ:AAPL)

Apple Stock: You’ve Been Warned (NASDAQ:AAPL)

The new model of apple iphone lies on the laptop keyboard close-up

Ivan Balvan

in my previous Article for apple (NASDAQ:AAPL), I warned that demand for the lower-end iPhone 14 models was weaker than expected, and it turned out to be true, as mainstream media later reported that Apple decided to cut production numbers in the short term.

In this article, I provide an update to show that demand for the newer iPhone 14 models continues to fall, even for higher-end models, and highlight the company’s growing concerns in the run-up to next quarter’s earnings report. . .

investment thesis

I continue to believe that Apple has a great business model, great products with strong brand equity, and run by a strong management team. However, I think this is a challenging environment for Apple as there are increasing risks and uncertainties for the company. I think the weakening in demand for its newer iPhone 14 models is worrying, as even the higher-end models seem to have lost interest and demand for these products continues to fall. On the other hand, the weak lower-end iPhone 14 models have been disappointing and could create short-term headwinds to production unit numbers, as Apple could revise the number down if demand falls.

Another concern Apple investors should be mindful of is China, where smartphone shipments recently declined, along with weakening retail sales in the third quarter, as consumer confidence remains weak due to tough policies. of covid adopted by the Chinese authorities and the impact of the real estate and technology sectors on the Chinese economy.

Overall, I would advise investors to stay the course on Apple as this is not a good time to raise the stock as the risk-reward outlook leans more to the downside in my opinion.

Demand for iPhones falls after strong initial response

According to data from the UBS Evidence Lab, their analysis showed that the strong initial demand we saw for the higher-end iPhone Pro Max is starting to wane. wane. Data from the UBS Evidence Lab looks at iPhone availability in more than 30 countries and also looks at iPhone supply chains and wait times.

We’ve seen wait times continue to weaken in recent days relative to post-launch, while the US is the only market that continues to be an outlier in terms of wait times. For the US, the wait time for the iPhone 14 Pro Max is now 27 days, higher than China’s 23 days and the rest of the world’s 21 days. As a result, the strength of the US region has translated into almost 30% direct sales for the iPhone.

As you can see below, the trends for the US continue to be that the iPhone 14 Pro and Pro Max are the two most preferred by consumers, while demand for lower-end models like the iPhone 14 and iPhone 14 Plus is pretty underwhelming, in my opinion. view.

Availability of iPhone in the US

Availability of iPhone in the US (UBS)

However, when we look at the relative trends of the iPhone 14 Pro and Pro Max, their demand has actually decreased in recent weeks, while the iPhone 13 Pro and Pro Max maintained their demand during the same period. This tells me of a worrying trend even for the higher-end models, as demand appears to be weaker than last year.

iPhone 14 Pro and Pro Max compared to iPhone 13 Pro and Pro Max in the US.

iPhone 14 Pro and Pro Max compared to iPhone 13 Pro and Pro Max in the US (UBS)

Decline in demand and implications for short-term results

as i said in my previous article that low-end iPhone 14 claims have been pretty weak, iPhone 14 demand is heavily skewed towards the high-end iPhone 14 Pro and iPhone 14 Pro Max. While this gives a boost in terms of increasing the average selling price for the September and December quarters, I think the high availability of low-end iPhones represents a risk for the second half of 2022 and 2023. This risk comes in Apple’s way of missing out on their units as they reduce production of lower-end models. In fact, last month, Apple announced that it will scale back plans to ramp up production of the iPhone 14 in 6 million units. Instead, it will produce a similar number of units as last year with a target of 90 million phones for the period.

While I think Apple will likely shift production focus from low-end phones to high-end phones, there could be a greater risk that lower-end models of the iPhone 14 will continue to lose units sold, which could push the numbers up. of production. down more than expected.

As a result, I see relatively little upside potential for the forecast unit of 48m in September and 83m in December, as early indicators show we are seeing downward demand after launch. In fact, there is increased risk to consensus production figures for the second half of 2022, as well as calendar year 2023, which currently stand at 84 million and 244 million respectively, according to Visible Alpha. The biggest risk, in my opinion, will be 244 million units for calendar year 2023, as there is a risk that low-end production will continue to shrink going forward as demand continues to weaken.

China’s weakness remains a short-term headwind

There are worrying trends for Apple’s iPhone business in China, as the country is struggling with multiple internal issues. July smartphone shipments in China were down 31% in July. While this is partly due to a lack of new models, I think the decline in smartphone shipments also indicates growing problems for iPhone demand in China, at least in the short term.

This is because China’s economy appears to be reeling as Covid-19 restrictions and closures in Chinese cities have curbed demand in July. In my opinion, this is likely to continue to cause weakness in the near term as China continues to adopt a zero covid policy approach. While the direct impact of the zero covid policy approach and city lockdowns is that there is less foot traffic in shopping malls and Apple Stores, the indirect impact is resulting in a high cost to the Chinese economy.

Recently, retail sales in China weakened in the third quarter, implying weakening consumer confidence and for Apple, there could be a risk that this implies lower demand for higher-end iPhone models.

Valuation

My 1-year target price for Apple is based on an equal weight of a P/E multiples method as well as a DCF method. For the P/E multiple method, I apply a 25x P/E multiple to the average of Apple’s FY2023F and FY2024F earnings per share forecasts. While Apple is simply growing at a 6% EPS CAGR over the next 2 years, I believe the 25x forward multiple is justified given the strong management team, strong brand reputation, as well as competitive advantages. which Apple will continue to enjoy in the future due to its leading position in the industry. For the DCF method, I apply a terminal multiple of 20x and a discount rate of 8%. I have factored in short-term weakness in my short-term financial forecasts for Apple, as I incorporate some of the risks arising from a weakening macroeconomic environment into my forecasts. That said, I have yet to price in a full recession scenario in my model for Apple.

Based on the two valuation methodologies, I arrived at a target price of $135 for Apple. This represents an 8% drop from current levels. While there is a potential short-term downside, as well as increased risks that unit forecasts fall short of expectations and demand from China may drop, I’m keeping my rating on Apple neutral as it continues to look good over time. long term. Apple continues to reap the benefits of a strong brand reputation, strong global demand, stellar management execution and a long history of success.

risks

Weakening of the macroeconomic environment

The global macroeconomic environment is facing an increasingly uncertain and gloomy period as global growth appears to be stalling as central banks raise interest rates globally to tackle rising global inflation. the IMF continues to see global challenges that will test short-term growth forecasts.

For Apple, while it can be argued that its products are an essential commodity for the digital world we live in today, it is still not immune to a global macro slowdown. In particular, Apple could see consumers less willing to switch phones and hold on to current phones longer during weak economic periods, while also switching from higher-end, higher-priced iPhone models to lower-end models. . If demand for Apple products falls more than expected due to the further weakening of the global economy, this will result in downward revisions to the stock price.

chinese demand

As Apple’s next growth engine given the country’s relatively lower penetration as well as rising wealth, China is an important market for Apple. As a result of the harsh covid 19 policies, as well as the crackdown on the tech sector and the problems facing the real estate sector, consumer confidence in the country is quite weak at the moment. As a result, I believe that demand in China represents one of the biggest risks for Apple, as it may drop sharply as the economy worsens due to the many challenges facing the country today.

Market share loss in smartphone markets

I still consider Apple to have one of the best and strongest competitive moats in the world as they have a strong brand globally and continue to strive to be at the forefront of technological innovation. The risk remains that Apple will need to continue to innovate to maintain this leadership position. While there are plenty of other smartphone players in the low-end and high-end markets, these players don’t currently enjoy the same brand recognition and equity that Apple does. However, if its competitors are able to come up with better features or better software, this may undermine Apple’s current dominant position in the industry.

conclusion

In short, Apple continues to face short-term headwinds as uncertainties and risks to the company mount. The recently released iPhone 14 models have seen demand decrease, both for the low-end and high-end models. This could indicate that demand, in general, is falling as consumers become increasingly cost-sensitive as the global economic situation worsens. In particular, there is a risk that Apple will lower its production numbers if lower-end iPhone 14 models continue to disappoint. In China, Apple risks demand for its products falling in the short term, as the Chinese economy is affected by zero covid policies, as well as the impact of the technology and real estate sectors on the economy. China. My 1-year price target is $135 for Apple, which is an 8% drop from current levels. As such, I’m keeping my rating neutral as I still think this is not the time to add Apple yet.

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