The Ap­ple of any in­vestor’s eye

This tech gi­ant is char­ac­terised by a mul­ti­tude of strengths and even if it doesn’t de­velop an­other prod­uct that is as suc­cess­ful as the iPhone, the odds are nev­er­the­less in its favour.

Finweek English Edition - - MARKETPLACE - Edi­to­rial@fin­week.co.za Dy­lan Martin is an in­vest­ment an­a­lyst at Citadel.

ap­pleInc. has the high­est mar­ket cap­i­tal­i­sa­tion in the world for a rea­son: un­prece­dented se­rial suc­cess in dif­fer­ent and in­no­va­tive prod­ucts and ser­vices.

Ap­ple boasts a myr­iad of strengths, in­clud­ing:

An ex­cel­lent brand, con­vey­ing af­flu­ence and lux­ury. With Burberry’s ex-CEO An­gela Ahrendts as Ap­ple’s head of re­tail, this is no ac­ci­dent. As a premium brand, Ap­ple can earn sig­nif­i­cantly higher mar­gins than its peers, as well as gain mar­ket share from first movers. A ful­fil­ment in­fra­struc­ture that is sec­ond to none, which is no co­in­ci­dence: CEO Tim Cook is a sup­ply chain ex­pert. Fur­ther­more, the com­pany en­joys a rare neg­a­tive cash con­ver­sion cy­cle as a re­sult of its very dom­i­nant po­si­tion rel­a­tive to its sup­pli­ers who fight tooth and nail for the priv­i­lege of an Ap­ple deal. This en­ables Ap­ple to in­no­vate rapidly, out­selling peers who run into sup­ply chain and cash flow prob­lems. A strong re­tail sales force and foot­print. A ro­bust fi­nan­cial po­si­tion with around $210bn in cash, which can be used for fur­ther R&D and ac­qui­si­tions. Share­hold­ers may also re­ceive some of this cash as a spe­cial div­i­dend when off­shore cash repa­tri­a­tion tax hol­i­days in­evitably come along. An “ecosys­tem” which fo­cuses on seam­less in­te­gra­tion from de­vice to de­vice – or “a kil­ler ex­pe­ri­ence”, as Tim Cook puts it. A track record of ex­e­cut­ing other com­pa­nies’ in­no­va­tions bet­ter and faster, which trans­lates into strate­gic agility. With its strengths, Ap­ple could cap­i­talise on “the next big thing” that changes our lives – just as the smart­phone did – and not nec­es­sar­ily have to be the first mover in what­ever that “big thing” turns out to be.

Although we don’t know what the next big thing will be, there will in­vari­ably be a range of op­por­tu­ni­ties. The “per­sonal In­ter­net of Things” – which in­cludes the likes of home au­to­ma­tion – is of­ten put for­ward as hav­ing po­ten­tial for Ap­ple dom­i­na­tion. You could, for ex­am­ple, lie in bed and use your de­vice to boil the ket­tle when you wake up in the morn­ing. This kind of thing could be­come as much of a “ne­ces­sity” as smart­phones are seen as to­day. If home au­to­ma­tion is viewed as a value ac­cre­tive in­vest­ment in one’s prop­erty, con­sumers may be will­ing to spend mean­ing­ful sums of money on as­so­ci­ated prod­ucts and tech­nolo­gies. So, if a com­pelling and seam­less home au­to­ma­tion so­lu­tion hits the mar­ket – which is some­thing that Ap­ple is very well-po­si­tioned to pro­vide – then the com­pany’s so­lu­tion, called “HomeKit”, could be the much-needed Se­nior vice pres­i­dent of re­tail and on­line stores at Ap­ple Ap­ple CEO en­core to the iPhone, plug­ging right into the “Ap­ple ecosys­tem”, while also be­ing un­der­es­ti­mated in its in­fancy by cap­i­tal mar­kets.

From driver­less ve­hi­cles and smart­watches to fi­nan­cial ser­vices and tar­geted ad­ver­tis­ing, there are many op­por­tu­ni­ties for Ap­ple – and these are just the known ones. Of course, there are also un­known op­por­tu­ni­ties as well as un­known risks. How­ever, given Ap­ple’s strengths, the odds are skewed in its favour.

At­trac­tively priced

Ap­ple is on a 2.1% div­i­dend yield but there’s more to the story. While Ap­ple spends around $11bn per year on div­i­dend pay­ments, it is ex­pected to con­tinue spend­ing even greater amounts on share buy-backs: in 2015, Ap­ple bought back stock worth $31bn. Es­sen­tially, buy­backs are equiv­a­lent to div­i­dend pay­ments in the way that they re­turn cap­i­tal to share­hold­ers. Viewed in this way, Ap­ple saw a stag­ger­ing 7.7% “share­holder yield” for the 2015 fi­nan­cial year, con­sid­er­ing div­i­dends as well as share buy-backs as re­turn of cap­i­tal. It is rare to find a com­pany with the strengths and brand of Ap­ple, so cheaply priced.

How­ever, one only needs to look at the fate of Black­Berry to re­alise the sig­nif­i­cant dis­rup­tion risk in this sec­tor. There­fore, Ap­ple stock needs to be held in a well-di­ver­si­fied port­fo­lio given what looks like a bi­fur­cated fu­ture for the com­pany: it could cap­i­talise on its weighty op­por­tu­ni­ties and con­tinue to do phe­nom­e­nally well or, in an al­ter­na­tive sce­nario, it could be dis­rupted as Black­Berry was. In a suf­fi­ciently di­ver­si­fied port­fo­lio, one can ac­cept this risk while en­joy­ing the po­ten­tial up­side to­wards which the odds are skewed.

The crux of the in­vest­ment case for Ap­ple lies in this ques­tion: can Ap­ple again in­tro­duce a prod­uct that is as suc­cess­ful as the iPhone? If it can, Ap­ple stock is a bar­gain. If not, then Ap­ple cur­rently sits on peak real earn­ings and is not quite so cheap.

While the mar­ket seem­ingly fo­cusses on quar­terly earn­ings num­bers and the iPhone, I believe that the big­ger pic­ture is be­ing ig­nored due to un­cer­tainty around ex­actly what the next big thing will be. The fact that some of the com­pany’s op­por­tu­ni­ties are cur­rently shrouded in un­cer­tainty doesn’t change the fact that the op­por­tu­ni­ties are there. All in all, the busi­ness has a strong, sus­tain­able and multi-faceted com­pet­i­tive ad­van­tage, good man­age­ment and, all risks and op­por­tu­ni­ties con­sid­ered, is at­trac­tively priced below $110 a share.

Tim Cook

An­gela Ahrendts

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