Company Overview

Apple Inc. (APPLE) is a technology company founded in California, USA in 1977. APPLE distributes smartphones, tablets, software applications, digital content, services, wearables and accessories. The company boasts of popular brands like iPhone, iPad, Mac computers, Apple Watch, Apple Pay and Apple Music.

APPLE relies on Research and Development (R&D) to grow its business. It has been expending about 4.6% of revenue on R&D in the past ten years. APPLE reaches millions of customers around the globe through its worldwide distribution network that comprises direct and indirect sales outlets. The ability to develop the operating systems for its products is a plus for the management of the company as it does not need to depend on third parties for software that control the operation of its hardware.

Arthur Levinson, the board chairman of APPLE, is a co-founder of the Biotechnology Company Calico Life Sciences. Timothy Cook became the chief executive officer of APPLE in 2011. Timothy had previously worked with Compaq and IBM.

Investment Thesis

APPLE has strong brands and a robust distribution network. Sales revenue has grown on a 3-Year Compound Annual Growth Rate (CAGR) of 11.3% owing to a strong demand for its products and services. Services sales include advertising, cloud, digital content and payment.

Though it accounts for less than 20% of total sales revenue, revenue from services has expanded faster than product sales in the last three years. In addition, services have a higher gross profit margin as a result of lower cost of sales to turnover ratio. Cost of sales to turnover for services is approximately 35% while that of products is roughly 67%.

APPLE leverages its technological expertise to provide improved and innovative products to its teeming customers through in-house and third-party developers. The operating systems designed for its products have endeared it to customers as they do not have to rely on other companies for the software support. Besides, its operating systems and application software make its products unique and generate additional revenue for the company. APPLE backs up third-party developers to design digital content and innovative software that work with its products.

APPLE has compensated shareholders with dividend for ten uninterrupted years. Dividend yield averaged 5.3% over the past seven years. In addition, the company generates a lot of free cash flow for the shareholders. However, debt level is rising.

The stock offers investors adequate return in terms of capital appreciation and dividend yield. But the current market price exceeds our fair value estimate. We are of the opinion that APPLE’s shares are overpriced at the current market price.

Valuation

We arrived at a fair value ranging from $136.27 to $156.75 for a share of APPLE. The stock appears to be overvalued as it is trading above our fair value estimate.

Financial Overview

Sales revenue increased across all product categories. iPhone recorded the highest year-over-year growth of 39.3% in revenue from $137.8 billion in 2020 to $192 billion in 2021. iPhone sales accounted for 52.5% of the total revenue of APPLE (2020: 50.2%). iPad produced $31.9 billion revenue which translated to a 34.3% improvement over prior year’s performance. Revenue from services grew by 27.3% from $53.8 billion to $68.4 billion between 2020 and 2021 while sales for wearable, home and other accessories jumped by 25.3% to close at $38.4 billion at 2021 year-end. In the same vein, Mac sales added $6.6 billion or 23% year-over-year. Altogether, the total revenue of APPLE leaped 33.3% to $365.8 billion in 2021 compared to a 5.5% rise in the preceding year.

China was the highest contributor to increment in revenue in the 2021 fiscal year. It was responsible for 30.7% of the revenue growth in 2021. The US followed by producing 27% of the increase in net sales. Revenue from China grew 69.6% to $68.4 billion in 2021 compared to declines recorded in the previous two years. The US, which produced about 38% of the company’s total, has had a consistent revenue growth. The revenue of $89.3 billion from Europe was equivalent to 24.4% of total revenue.

Though it rose by 25.6% year-over-year to $213 billion in 2021, total cost of sales formed 58.2% of turnover compared to 61.8% in the earlier year. Consequently, gross profit margin of APPLE increased from 38.2% to 41.8%. Operating income jumped 64.4% year-over-year to $108.9 billion even though costs have risen. Pre-tax and post-tax income of $109.2 billion and $94.7 billion respectively were tantamount to year-over-year increase of 62.8% and 64.9%.

Total assets gained 8.4% to $351 billion at 2021 year-end as against a 4.3% decline in the preceding year. Total equity, on the contrary, dropped 3.4% in 2021 compared to a 27.8% fall in the year before. APPLE is a highly geared company. It had a total debt of $124.7 billion at 2021-year end compared to $112.4 billion in the prior fiscal year. Total debt was about twice the total equity in 2021 (2020: 1.7 times total equity). But the company makes ample profit and operating cash that can sufficiently cover its debt obligations. In addition, total debt to total assets averaged out to 32.9% over the past five years. APPLE’s solvency, in our opinion, is not under threat.

Business Risk

APPLE is susceptible to competitive pressure owing to the availability of many cheaper substitutes for its products. Consequently, sales and profit margins are prone to attack. Fast-paced technological change characterises the market and it must spend a lot to keep up with change in terms of design, performance and quality. Besides, APPLE is exposed to laws and regulations in multiple jurisdictions such as privacy, antitrust, intellectual property and data security laws. Non-compliance with applicable laws and regulations can result in substantial damages that may hurt the company’s profitability and reputation.

Recommendation: Overpriced