Apple’s (AAPL) Worldwide Developers Conference (WWDC) is just around the corner (June 2-6), and we would expect the iPhone-maker’s equity to face some volatility during the conference and as it heads into the expected 7-for-1 stock split, which will go into effect June 9. Given all the moving parts in the next couple weeks, we plan to release an updated 16-page report on Apple the week after the split, or the week of June 16, so please be sure to stay active on our website for the update. On a split-adjusted basis, members should expect our valuation of the iPhone maker to come in at just over $100-$105 each (roughly in-line with its current $715 per share estimate, unadjusted for the split). No real surprises in the new report – just $715 divided by 7 and related adjustments. That being said, the fundamentals supporting our above-market fair value estimate of Apple keep getting better.
At this year’s WWDC, it has been rumored that we’ll see an iOS 8 reveal with potentially a major new addition/application called Healthbook, which would be Apple’s first major step into health and fitness tracking. The Healthbook platform will have a “cards-style interface like Passbook, and track measures including Heart Rate, Blood Pressure, Respiratory Rate, Weight, Blood Sugar and more (source: TechCrunch).” Mobile payment software and a car-entertainment operating system could be announced, and the Financial Times recently reported that a home-automation platform for the iPhone should be expected. The convergence of concepts onto the iPhone seems to be never-ending, and Apple’s idea-generation capacity to add value within its product suite continues to be top-notch within the tech sector, in our view. TechCrunch also reported that the conference will include an improvement to Maps and the next version of Mac OS X (codenamed Syrah), which will likely include a major visual redesign. Apple’s WWDC will be quite an exciting event, and interesting new features and developments are on the horizon.
In other Apple news, we were very pleased to see recent analysis support the tremendous upgrade opportunity that we expect as it relates to the firm’s larger iPhone 6. According to Kantar Worldpanel ComTech data, nearly 90% of iPhone owners in the US who plan to change devices over the next 12 months say they will stick with Apple and roughly 8.5% of Samsung users plan to move to Apple (with only 3.7% doing the opposite). This is incredible retention for Apple’s iPhone and supports our thesis on the coming iPhone 6 launch:
The iPhone 6 will have a larger, sapphire crystal screen, and a faster and more efficient A8 chip. The screen size of the iPhone 5s is currently 4 inches, and we think the iPhone 6’s 4.7 inch screen size (which is expected to be released in August) or 5.5/5.6 inch screen size (which is expected to be released in September) will hit the sweet spot of usability for consumers. From our research, the iPhone 5s is a bit small for many applications (both on the enterprise and consumer level), especially as workers and consumers grow more comfortable with the larger iPad in day-to-day activities.
Though there will be other features of the iPhone 6 that will attract iPhone owners to upgrade, we think the larger size will be the most important selling point. We think the iPhone 6 launch could drive an upgrade rate of 12%-14% of existing iPhone owners. Though this rate approximates peak levels, we think the iPhone 6 will have even greater success on the basis that consumers didn’t truly know the optimal usability size until the iPad proliferated. With the iPhone’s installed base of 260 million users, an upgrade rate in the mid-teens would offer a significant boost to Apple. Because the iPhone is a more portable, workable device than the iPad, we don’t think much cannibalization will happen as a result of the size adjustment…Apple is expected to produce 80 million iPhone 6 handsets this year. We’re very excited about what the ‘lack of cannibalization’ means for Apple, especially as new and more powerful iPad versions hit the market.
In yet more Apple news, it looks as though the sell-side analyst community is starting to catch up on Apple’s significant valuation opportunity – a good thing. Last week, for example, Goldman Sachs, Piper Jaffray and UBS all raised their price targets on the iPhone maker to roughly the area of our current pre-split fair value estimate ($715 per share). Loyal members of Valuentum know that our fair value estimate has been well above-market for some time, and we trust you are very pleased with the significant gains in Apple in recent months. According to Factset, the average price target on Apple is just shy of $640 per share, so we think there are more price-target increases coming. For those that may not be familiar with the research industry, it is common for sell-side analysts to follow the herd when it comes to both earnings estimates and price targets.
If all this weren’t enough, rumors hit the wire Thursday that Apple could also be working on a TV set and a wearable computer, both brand new product categories for the firm. It was great to hear Apple veteran Eddy Cue, SVP of Internet software and services, reveal his opinion that Apple’s scheduled product releases in 2014 are, in his view, “the best product pipeline” in 25 years! We think this statement is much more than a company veteran being optimistic, especially with so many ideas in the works. The middle of this decade could be absolutely marvelous for Apple.
All told, the recent strong stock-price performance of Apple has propelled returns in both the Best Ideas portfolio and Dividend Growth portfolio higher. We don’t think we could be happier with the iPhone-maker’s improving fundamentals or more excited about the new products and applications in its pipeline. Apple will be buying back a significant amount of stock through the end of 2015 (~$130 billion), and while this will reduce balance-sheet cash dividend coverage, we think Apple is a Dividend-Aristocrat to be on the basis of its tremendous cash-flow generation. We’re reiterating our above-market fair value estimate on shares and don’t expect to make any changes to our weighting in the actively-managed portfolios.
What is considered a ‘Best Idea’ at Valuentum?
A best idea in Valuentum parlance is a holding in the Best Ideas portfolio and/or the Dividend Growth portfolio. We typically add shares to the Best Ideas portfolio when they register a high rating (a 9 or 10 = a “we’d consider buying” rating) on the Valuentum Buying Index and hold them until they register a low rating (a 1 or 2 = a “we’d consider selling” rating) on the Valuentum Buying Index. We don’t add all firms that register a high score on the Valuentum Buying Index to the actively-managed portfolios due to sector weighting or overall market valuation considerations, among others. The Valuentum Dividend Cushion is a key factor behind adding companies to the Dividend Growth portfolio and is used in conjunction with a company’s annual dividend yield, its price-to-fair value ratio and Valuentum Buying Index rating.