I’ve been a skeptic when it comes to Apple Inc. (NASDAQ:AAPL) for some time now. So far, that skepticism has seemed downright foolish, with the AAPL stock price up a torrid 46% year-to-date. But, to be honest, there really hasn’t been all that much in 2017 that has changed my mind about AAPL stock.
Valuation here still comes down to the long-term positioning of the iPhone. As I pointed out all the way back in February, non-iPhone revenue has been almost bizarrely flat for years, although it did finally grow in Apple’s FY 2017.
I still see risk of a potential peak in iPhone sales in the near-term, the same risk that at times has kept a lid on the AAPL stock price in the past. The gains in AAPL stock haven’t come because the business has changed all that much. FY18 EPS estimates, for instance, have risen.
But most of the gains in Apple stock made this year have come from earnings multiple expansion, not expectations of higher near-term growth. That in turn suggests that the market is less worried about those risks than it was a year ago. I disagree on that front, although I appear to be in the minority on that front.
An iPhone Peak?
Though the market is supposed to be forward-looking, it hasn’t always been when it comes to Apple stock. The stock has tended to dip (see reasonably big downward moves in 2012-13 and 2015-16) when a new iPhone isn’t on the horizon and then rally as optimism for the next launch builds.
I’ve wondered whether the AAPL stock price could maintain its run through the iPhone X launch, and admittedly so far it has. In a way, the delays in iPhone shipments may have helped Apple stock in that it extended the ‘story’ of X sales into calendar 2018.
But long-term, the concern about iPhone sales shouldn’t be disregarded. According to the 10-K, unit sales in fiscal 2017 were up 2% year-over-year but still down over 6% from FY15 levels. Total sales in China, predominantly iPhone revenue, are down 24% over the past two years.
The $999 price tag on the core iPhone X will help selling prices and provide a nice boost to FY18 revenue, but the idea that Apple is this fast-growing behemoth is belied by the numbers. Overall, FY17 revenue was down 1.9% from levels seen two years earlier.
Sales probably actually have grown on a constant-currency basis, but very modestly. And so the bearish (or at least cautious) case relative to the AAPL stock price remains. If smartphones become commoditized, or even if upgrade cycles extend, iPhone revenue could begin to decline. The rest of the business simply isn’t built to manage that.
AAPL Stock Beyond the iPhone
Amazingly, the iPhone probably remains underrated from a financial sense. Without question, it is the most successful product in the history of mankind. One could maybe make an argument for the Ford Motor Company (NYSE:F) Model T, but Ford did make other cars.
Apple has created the most valuable company ever and 62% of its revenue comes from the iPhone. It’s impressive, to be sure, but also a potential problem for Apple stock because Apple’s non-iPhone products have been consistent. The iPod faded. The iPad faded and continues to see sales decline (-7% in FY17).
The Mac business has been solid, but sales growth has been unspectacular: a 2.4% CAGR over the past three years. In the context of long-term declines at PC makers like HP Inc (NYSE:HPQ) and Dell Technologies Inc (NYSE:DVMT), that performance is good, but it hardly seems enough to support more upside in Apple stock.
Overall, non-iPhone revenue barely moved for years. The figure increased from $77.8 billion in fiscal 2012 to $78.9 billion in fiscal 2016. But Apple did make some progress last year. Revenue excluding the iPhone actually gained a solid 11%, led by double-digit growth in Mac, Services, and Other Products.
CEO Tim Cook has prioritized these categories, notably citing a $50 billion target, which is double FY16 levels, for Services over the next four years. But there’s the question as to how much it really matters. The Services goal almost certainly will require an acquisition and likely a large one.
Even double-digit organic growth from that business adds barely a point to Apple’s overall sales. Again, this is a company worth $875 billion. A $50 billion revenue target would be enormous in the context of almost any other company. For Apple, it barely makes a ripple.
Other Drivers Behind the AAPL Stock Price
That’s true with some of the other supposed drivers. Apple’s huge pile of overseas cash has made it a supposed winner from tax reform. But the company’s effective tax rate already is in the 25% range, thanks to overseas efforts that are under regulatory review.
The Apple Cash Pay offering, a competitor to Venmo from PayPal Holdings Inc (NASDAQ:PYPL) and Square Inc (NYSE:SQ), could be a roaring success and have little or no impact on the AAPL stock price. Apple stock is the iPhone, for the most part.
The product, again, accounts for over 60% of revenue and likely a higher proportion of profit. I still think long-term, iPhone sales will face challenges and even a 47% YTD gain hasn’t disproved that argument, yet. So far investors are taking the other side of that argument. If that changes, though, Apple stock will suffer.
As of this writing, Vince Martin has no positions in any securities mentioned.