A Conservative Outook For Apple’s Present And Future

17Apr12

In an earlier article, entitled “A Conservative Outlook For Apple’s Present and Future, Part 1”, I examined in detail Apple’s (AAPL) current product lineup as well as other drivers of revenue growth. In this second article, I outline a very conservative business future for Apple and then, using these projected financials, I calculate an estimate of the share price over the next five years.

Share price estimate

To calculate share price, I have selected a common method which I believe originated with Benjamin Graham: a reasonable estimate of enterprise value (market cap) on a given date is the cash on hand on that date plus the future stream of discounted earnings:

Stock price = Cash on hand + discounted earnings over next 11 years

This is one of several possible methods of calculating a share price. Others use discounted dividend streams or free cash flow streams; Apple distributes little in dividends and its free cash flow is well above its earnings, so I will use the more conservative (and easier to deal with) earnings.

For discount rate, each year’s earnings will be discounted by 10% per year:

Discount Rate = 10%

This means, e.g., in calculating the stock price for 2013, the 2014 earning will be multiplied by 0.90; 2015 earnings by 0.81 = 0.90 x 0.90; 2016 earnings by 0.73 = 0.90 x 0.90 x 0.9; etc, before being summed.

Cash on a future date is taken as the actual cash today ($97B) plus accumulated earnings out to that date. The share price calculation assumes that Apple will continue to have 930 million shares outstanding and everything here ignores dividends.

Revenue Growth

Apple has grown revenues at a furious pace: 68% in the current trailing twelve months [TTM] ending fiscal Q1/2012. To grow at that rate, Apple added $52B in revenue generating production over the past 12 months. Going forward I will assume that $70B is the maximum revenue generating production that can be added in a year and that the growth over the next five years will be limited to that amount. Beyond the next five years, the projected growth rate will be limited to a modest product replacement rate of 8%.

The revenue growth rate is shown in Graph1 below.

As you can see, in this projected future Apple evolves from a monster growth company today to a mature consumer products supplier in five years.

Net Margins and Earnings growth

Net margin (bottom line earnings/top line revenues) is the factor that takes revenues into earnings. Apple’s net margin has grown steadily over the last decade, from 15% in the year ending in Q1/2008 to 27% in the year ending in Q1/2012. In the projected future, Apple’s net margin remains at 27% during the next two high-growth years, and then declines steadily by 5% of its value each year over subsequent years. This is shown in Graph 2 below.

The decline projected for net margins is not as severe as the decline of revenue growth. While the growth rate is declining, the revenues continue to grow and so it becomes possible to maintain margins.

Future Outcome: Revenues, Earnings, Market Cap and Stock Price.

The Table below summarizes the financial and investment results calculated as described above. Actuals are shown in bold type and future values, calculated using the method above, are shown in plain text.

Year Ending
Revenue ($B)
Earnings ($B)
Cash ($B)
Market Cap ($B)
Share Price ($/sh)

Q1/2007
$21
$2.77
$15

Q1/2008
$27
$4.38
$28.49

Q1/2009
$39
$7.33
$41.40

Q1/2010
$47
$10.27
$50.22

Q1/2011
$76
$17.91
$81.94

Q1/2012
$128
$35.11
$137.46
$697
$749

Q1/2013
$198
$53.46
$213
$805
$866

Q1/2014
$268
$72.36
$288
$920
$990

Q1/2015
$338
$86.70
$363
$1,042
$1,120

Q1/2016
$408
$99.42
$439
$1,168
$1,256

Q1/2017
$478
$110.65
$514
$1,298
$1,396

Table 1: Past financial results (in bold type) and future calculated financials and stock price (in plain type) for Apple.

The data displayed in Table 1 ends in Q1/2017. Calculating a stock price for that date requires earnings estimates, using the assumptions of Graphs 1 and 2, out to Q1/28. At that point the revenues have grown to $1,900B and earnings to about $200B.

Discussion of Results.

Revenue. To begin with, we need to ask whether the results in the Table above– especially the revenues– pass the sanity test. I would argue that they do pass the sanity test, but they point to an enterprise of unprecedented dimensions. By Q1/2017, Apple’s revenues in this future will surpass today’s revenues of Exxon Mobil (XOM); after that the growth is slowed to 8% and still, by 2023, Apple’s revenues of $758B are 5% of today’s U.S. Gross Domestic Product. If there is any doubt about the sanity of this picture, look at the declining rate of revenue growth in Graph 1 (above) and then recall that the iPhone is just taking off in China; iPad sales are exploding after less than two years on the market; and revenues of the Mac, a product first introduced thirty years ago, grew at 24% year over year in Q1/2012.

(It may also be clear to the reader why Part 1 of this article was so positive about Apple’s future, while the growth assumed in this calculation was throttled back so severely. Without throttling back revenue growth, revenues rapidly rise to levels that are not plausible today– but which Apple may make plausible tomorrow.)

Earnings. The near term prediction for earnings in the Table above is that a year from now, in the year ending Q1/2013, Apple’s earnings will grow to $53B, or $57/per share on $198B in revenue. On that pace Apple would report revenues of about $38B and earnings of about $10.00 per share when it announces Q2/2012 results in two weeks. Those results will provide a good benchmark on these predictions.

Stock Price Now we come to the entire reason for undertaking this exercise: to get a handle on where the stock price might be headed. The share prices calculated in Table 1 are shown visually in Graph 3.

Here we have a very encouraging bottom line to this exercise. First of all, today’s share price is well below the $750/share that falls out of the rather conservative growth picture that I have adopted. Then, two years into this future, Apple share price rises to nearly $1000. At that point, Apple has $220B in cash ($236/share), earnings of $72B ($78/sh) and a P/E ratio of about 11. In the fifth year, ending Q1/17, the share price has risen to nearly $1400 about half of which is cash, and the P/E is about 12.

Conclusion. I undertook the exercise above to satisfy my investor curiosity about how secure Apple’s future might be and how much risk there is in holding an overweight position. The most startling conclusion from all this is that in spite of the huge size to which Apple has grown today, its current growth rate, even as it declines rapidly, carries the company to a size and a market value which, to my knowledge, are unprecedented in the history of business and finance.

In fact, in Apple we are seeing the first truly post-Marxist industrial company– a company whose manufacturing is tapping the vast labor pool fleeing the desperately poor Chinese countryside for a better life, and a company whose markets include the huge emerging middle class of the former Communist bloc countries.

Of course, all of these predictions assume that the world economy avoids a catastrophe, by no means a sure thing in today’s environment. In fact Graph 1 shows that the “Great Recession” of 2009 did cause major dislocation. It also shows that the effect was temporary and that Apple, like other great enterprises, came back from it strengthened and wizened. But it also assumes no new blockbuster product introductions by Apple, including the much-rumored Apple TV. So there is both upside and downside uncertainty in this future.

Finally, as earnings are announced in a few weeks and then in future quarters, their level of agreement with the projected values here will provide calibration as to whether the real future is better or worse than what was projected here.

Learn more about Ron Sloy.

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