Alongside the rest of the market, consumer tech giant Apple Inc. (NASDAQ:AAPL) had a terrific 2017. Apple stock rose nearly 50% while the S&P 500 rallied 20%.
But, also alongside the rest of the market, Apple has struggled in 2018. Year-to-date, Apple stock is up only 1.5%. The S&P 500 is down about 1.5%.
The big question for Apple stock is whether or not these struggles will persist for the balance of the year.
Maybe. Estimates continue to come down for iPhone shipments in the coming quarters, mostly thanks to persistently weak demand for the iPhone X. That will hang over Apple stock for the balance of 2018.
But I don’t think weaker-than-expected iPhone X demand will be the focal point of Apple stock this year. Instead, the company’s capital returns program and its plan to reduce its net cash balance from $163 billion to zero will be front and center. Investors will also be paying close attention to the company’s Services business and how that ramps to offset stagnant iPhone demand.
Overall, in 2018, the positives offset the negatives on Apple stock. I expect AAPL to rise to around $180 by the end of the year.
Here’s a deeper look.
Apple Doesn’t Need Strong iPhone Growth
There is no question about it. Apple’s iPhone unit growth is slowing down and stagnating for the first time in company history. And that really isn’t AAPL’s fault. Smartphone growth globally is slowing thanks to developed market saturation and the durability of current smartphones.
Essentially, in developed market, everyone who wants a smartphone already has one, and phones that are 2-3 years old normally work just fine.
Historically, Apple has needed strong iPhone unit growth to power its growth narrative. Thus, looking back several years, whenever iPhone unit growth didn’t live up to expectations, Apple stock dropped.
But that really isn’t the case today. By now, everyone and their best friend is fully aware of just how weak iPhone X demand has been and continues to be. Apple stock was initially hit big on those concerns in late January/early February. But it has recovered strongly from that sell-off, and is currently not far off from all time highs.
Why the difference this time around?
Because the Apple of today doesn’t need strong iPhone unit growth to power its growth narrative.
First, average selling prices on those iPhones are going up by a ton, so total iPhone revenue is actually climbing despite flattish unit growth.
Second, Apple’s non-iPhone businesses are ramping with exceptional pace. The Services business is a high-margin business growing at a 20-30% clip. Everyone is excited about the growth prospects of that business as Apple starts to monetize its user base from multiple angles.
The Apple Watch is red-hot, and all signs point to that product just
running away with the smartwatch market (much like the iPhone has run away with the smartphone market). iPad sales are bouncing back, and exciting new Mac products are in the pipeline.
Third, Apple’s capital returns program is about to get a big boost thanks to tax reform. Not only is the company saving a bunch of money through lower taxes, but management has also vowed to reduce its net cash balance from a whopping $163 billion to zero. That means bigger buybacks and juicier dividends, the combination of which gets investors excited.
Path To $180 And Up Is Clear
Because the positives (higher iPhone ASPs, growth in the non-iPhone business, and boosted capital returns) outweigh the negatives (weak iPhone X demand), Apple stock should head higher through the end of the year.
How much higher? I think the stock can rally to $180 and up.
Revenue growth should run around 5% per year over the next 5 years thanks to higher iPhone ASPs and continued growth in Apple Watch and Services. Operating margins should run back up to 30% thanks to high-margin Services growth and higher ASPs. The tax rate should come down to about 15% on a go-forward basis.
The share count should be dramatically reduced thanks to bigger buybacks, so the diluted share count should run around 4 to 4.5 billion in five years.
All together, 5% revenue growth from this year’s projected sales base of $262 billion gets you to $334.4 billion in revenues in 5 years. A 30% operating margin implies operating profits of $100.3 billion. After 15% taxes and on 4.25 billion shares out, that equates to $20 in earnings per share.
A historically normal 14.5-times multiple on $20 earnings yields a five-year forward price target of $290. Discounting that back by 10% per year, you get to a present value of around $180.
Bottom Line on AAPL Stock
Weaker than expected iPhone X demand will take a backseat in 2018. Instead, capital returns, Services ramp, and continued Apple Watch strength will be front and center.
As such, AAPL stock should head higher into the end of the year.
As of this writing, Luke Lango was long AAPL.
