The share price of Apple surged to an all-time high after comments by Berkshire Hathaway CEO Warren Buffet that he really likes the company. In fact, he said he likes it so much that he would buy the entire company if he could!
To many observers Buffet’s current love affair with Apple seems odd - Buffet is notoriously averse to investing in technology companies, so much so that he never invested in his good friend Bill Gates’ Microsoft.
While the strength of the Apple brand is well-known and highly regarded by consumers and investors alike, there are two additional, if not more important aspects that enhance the company’s value appeal and would have convinced Buffet to pour capital into it.
(1) Apple is evolving
Up until recently, the market evaluated Apple as if it were a typical hardware manufacturer, destined to see its margins erode as competitors hone in on its market share. While Apple’s products remain valuable and produce the lion’s share of its revenues, the best are found in the relatively smaller but fast-growing services segment.
Apple now has over 1.3 billion active devices around the world (a 30% increase since it reached the milestone of 1 billion in January 2016). Each of these 1.3 billion devices are like mini retail stores that allow Apple to grab revenue from apps and subscription services like Apple music, which now has 38 million subscribers.
The revenue from services is stable (relative to iPhone-sales), recurring, fast growing and generates high margins. In 2018 it is expected to generate $35 billion in revenue - in fact, if Apple’s service segment was its own stand-alone business, it would now be in the Fortune 100. This powerful and valuable business is growing at 25% annually, with predictions that it will contribute more than 50% to Apple’s revenue growth over the next 4 years.
(2) Apple is a cash flow machine
Apple should generate a total of $130 billion of free cash flow in 2018 and 2019, which is equal to about 15% of its current market value. Given its low capital requirements, most of this cash will be returned to shareholders via share repurchases and dividends. (After its first quarter results, the company authorised another $100 billion of share repurchases while raising its quarterly dividend by 16%.)
However, the company isn’t resting on its laurels though - the excess free cash mentioned above is what’s left over after it will spend a substantial amount on research and development of new product lines, and should be considered investment into future growth.
Apple will also benefit significantly from the new tax law in the United States: For a one-time tax bill of $38 billion, it can return its massive $270 billion offshore cash hoard back into the US. This allows for an even larger capital return to investors (again in the form of share repurchases and dividends). No doubt that Apple is an absolute cash flow machine.
Shares not expensive
While there are more aspects to the investment case than mentioned in this article, it is clear that Apple is a company in rude health.
Despite the strong appreciation in its share price over the past year or so, Apple is still not an expensive share and is likely undervalued by the market: It is trading on a P/E of 13.7 given that it should earn approximately $11.5 of earnings per share in the current year, and after excluding its net cash position of $32 per share. Not a bad price to pay for one of the world’s most profitable and valuable companies, especially when measured relative to the S&P 500 and the high valuations in the global tech industry.
Wim Prinsloo, CFA
Portfolio Manager at True North Capital Management
Wim Prinsloo serves as portfolio manager at True North Capital Management. He holds an honours degree in investment management from the University of Pretoria and is a CFA charter holder.
Wim’s work at True North includes the management of the firm’s equity and property unit trusts, development of its investment processes and ensuring best-in-class service to clients. He benefits from 7 years of experience in the investment industry and is a member of the Investment Analyst Society of South Africa.