For a brief time late last year, it looked like the market was coming around to my long-held skepticism toward Apple (NASDAQ:AAPL). The shares fell sharply in the last three months of 2018. At the lows, AAPL stock had lost over one-third of its value.
The fear was slowing iPhone sales — long a large part of the bear case on AAPL. Egged on by the plunging broader market, the Apple stock price unsurprisingly fell, losing almost 24% in the final two months of the year while the Nasdaq Composite index shed 9.4%.
So far in 2019, however, investors seem much less worried. AAPL has climbed back, rising 29%. But the problems still are there and, in fact, they’re getting worse. iPhone sales look like they’re stalling out, which puts pressure on the services business. The news on both fronts hasn’t been great of late yet Apple stock keeps climbing. Once again, I believe it’s gone too far.
Hardware Problems for Apple Stock
The core part of the bear case for Apple — and the reason AAPL stock, even at the highs, traded at relatively low earnings multiples — is that iPhone sales growth is stalling out, and could get worse. Replacement cycles are lengthening. Incremental improvements are less impressive.
Apple is trying to improve the camera in its next line, for instance, but that’s not of enormous interest to many current iPhone owners. With unit prices around $1,000, Apple can’t do much on the pricing front, either.
And the iPhone still drives more than 60% of revenue even with iPhone sales dropping 15% in fiscal Q1. If those sales stay negative, Apple’s growth is going to grind to a halt.
That problem doesn’t seem to be getting better. Analyst firm OTR Global just cut its estimates for fiscal Q2 and fiscal Q3. Credit Suisse (NYSE:CS) is projecting a 12% decline this year. Another smaller outfit is projecting weakness as well.
That’s the revenue problem. Meanwhile, Apple surprisingly settled with Qualcomm (NASDAQ:QCOM) — which will hit the iPhone on the cost side as well, reportedly to the tune of $9 per unit. With Intel (NASDAQ:INTC) unable to deliver its 5G modem on time, Apple really had no choice.
Again, worries about hardware that sent the Apple stock price tumbling just a few months ago. Yet with those worries mounting, investors seem surprisingly sanguine.
The Services Issue
Apple is betting that its services business can pick up the slack from a growth standpoint. As I argued back in February, I simply don’t see that business as big enough. That category generated just 13% of revenue in the first quarter, if admittedly at higher margins.
Here, too, there’s concerning news. Major companies are getting tired of paying the so-called “Apple tax” for running subscriptions through iPhone apps. Netflix (NASDAQ:NFLX) cut off in-app subscriptions at the end of 2018. Now, streaming music provider Spotify (NYSE:SPOT) has filed a complaint with the European Commission over the App Store.
To be sure, the concerns about the App Store don’t mean the Services business is going to stop growing. But the increasing unease of major customers to keep paying as much as 30% to Apple is a problem. And, again, AAPL stock has risen almost 30% this year. From here, between disappointing earnings, rising hardware concerns, and pressure on a key (and enormously profitable) revenue stream in services, the gains don’t seem to much make sense.
AAPL Stock Is Cheap, But…
AAPL bulls might respond that Apple stock is cheap — and it is. Backing out the company’s net cash, the shares trade at about 15x FY19 analyst EPS estimates.
But in the context of current results, even that multiple doesn’t seem all that cheap. At 15x, there’s an assumption that earnings are going to grow for years to come. And it’s difficult to argue forcefully that will be the case.
From a more near-term standpoint, the question is why AAPL stock has been so strong in 2019. To be sure, some investors may have seen the late 2018 sell-off as overdone — and perhaps it was. But the stock now is back above $200; it’s been quite a bounce.
And with that bounce, AAPL stock truthfully looks expensive. 2019 has been great to Apple as a stock; but it’s actually been a disappointing year for Apple as a business. It’s going to have get a lot better, quickly, for Apple stock to even hold these levels.
As of this writing, Vince Martin has no positions in any securities mentioned.