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Dilantha De Silva
Dilantha De Silva
Articles (118)  | Author's Website |

Citigroup Assigns $400 Target Price to Apple

There are 5 catalysts for growth according to analysts, but the valuation is rich

There’s no shortage of bulls for Apple Inc. (NASDAQ:AAPL) even though shares have already appreciated 170% over the last five years. The continued outperformance of tech stocks was driven by the increasing adoption of technologically advanced solutions in almost every region of the world. An acceleration of this trend is expected by many analysts as multinational companies and government authorities are investing billions of dollars in infrastructure development projects to create a platform to enable the growth of concepts like the internet of things.

Apple can be expected to benefit from these favorable macroeconomic developments. At the same time, the company is diversifying into other business segments such as financial services and wearables to offset the decline in mobile handset device sales. As reported by Barron’s, Citigroup analyst Jim Suva has identified five catalysts that could lift the share price to $400.

  1. The launch of the 5G-enabled iPhone.
  2. Market share gains in the global smartphone industry.
  3. Growth of the wearables segment (AirPods, Apple Watch, etc.).
  4. The exponential growth of services revenue (Apple TV+, Apple Care, Apple News+, Apple Arcade, Apple Card, Apple Pay and iCloud).
  5. Wall Street estimates for iPhone sales and company revenue are already too low, which would be easily beaten by Apple in the coming quarters.

The target price assigned by the analyst is now the highest among Wall Street peers for the tech giant, and many other notable analysts remain bullish on the stock.

Source: TipRanks

Warren Buffett (Trades, Portfolio), one of the major shareholders of Apple, has remained positive on the company's prospects ever since Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) first invested in 2016. According to company filings, Buffett’s conglomerate is the second-largest shareholder of Apple, behind The Vanguard Group.

In this analysis, Apple’s prospects will be assessed along with its current valuation multiples to determine the best course of action for investors.

Recent developments paint a positive picture

The company announced a few initiatives over the last couple of months that are broadly supportive of future growth.

First, Apple is planning to develop its own processors to be installed in Mac computers starting in 2021. The company is ditching Intel Corp. (NASDAQ:INTC), citing the chipmaker’s inability to deliver on its long-promised 10 nm processors. The initiative to manufacture chips in-house will dramatically reduce the cost of manufacturing devices in the coming years. On the other hand, Apple will be less reliant on third-party vendors, which would make it possible to deliver on its promises regarding the launch of new products. In the past, the company has received backlash from consumers for postponing the introduction of promised features on time. The delay in bringing a 5G-enabled iPhone is a classic example of this.

Second, Apple TV+ finally seems to be on the correct path to win consumers. The service, which was unveiled last November, failed to gain traction as competition from Netflix Inc. (NASDAQ:NFLX) and The Walt Disney Co. (NYSE:DIS) proved to be difficult to combat. The key differentiator was the massive library of content of its closest rivals. To be truly competitive, Apple has decided to buy catalog content from other networks and studios. As reported by Bloomberg on May 19, the company is now open to producing films and TV series in partnership with renowned studios. These decisions will help the company improve the quality and quantity of Apple TV+ content, which could prove to be a game changer in helping it gain new subscribers. The video streaming industry is nowhere near a slowdown as Statista is projecting the sector will grow at a compounded annual rate of 10.1% through 2024.

Third, Apple is actively pursuing growth opportunities in the health care industry in a bid to leverage its iPhone installed base of over a billion devices. The company has already launched multiple products and services to become a go-to solutions provider in the digital health care space. Below are some of these measures.

Product/Service

Comments

Apple Health

This built-in activity tracker in iPhone devices helps users keep a record of fitness activities and makes it easier to connect with third-party health apps.

ResearchKit

This open-source application development framework makes it possible for medical researchers to collect personal data of Apple users to improve the outcome of their studies.

CareKit

This platform allows users to track health conditions to identify potential risks early. For example, Corrie Health App, developed by Johns Hopkins University, helps Apple users monitor symptoms of a heart attack. The app sends out emergency notifications to chosen devices once the user is experiencing heart difficulties.

Apple Health Records

This electronic health recording system allows users to store all relevant health metrics in their iPhones to be used by medical professionals.

Apple Watch

This wearable enables the monitoring of blood pressure, diabetes and sleep.

AC Wellness

An in-house health clinic launched by Apple, which is open to its employees. If the experiment is successful, Apple might roll out this product to the public as well.

Source: Company filings and press releases

The many initiatives taken by Apple to make a grand entry into the health care industry have gone unnoticed by the majority of investors. CEO Tim Cook confirmed in 2019 that Apple would no longer be a tech giant by 2025, but rather a services company that touches every aspect of human lives.

Fourth, Apple introduced a low-cost iPhone in April that costs $399, which is a step forward in attracting new customers from important target markets such as India. Apple has historically proven to be a failure in India; its market share was negligible in the country in 2019. As illustrated below, the company was not among the top players in the Indian smartphone market.

Source: Counterpoint Research

The failure to gain traction was a direct result of the hefty price tag of many iPhone devices, often surpassing $1,000. In the fourth quarter of 2019, the company changed its stance with the pricing strategy by marking the iPhone 11 at a starting price of $699. This yielded immediate results in India as the company reported a record number of smartphone shipments to the country.

Source: Canalys.

The new iPhone SE, released on April 20, is a reflection of this low-cost strategy. It will help Apple gain traction in underserved international markets. Amid the maturing nature of the U.S. smartphone industry, Apple seems to be doing the right thing by focusing on other high-growth regions to drive future earnings.

The latest developments paint a positive picture for Apple’s future, which is in line with Citigroup’s expectations. However, a careful analysis of the valuation level is required to reach an investment decision.

The best course of action will depend on the investor's risk tolerance

Although the prospects are promising, Apple is no longer trading at cheap multiples. According to data from Eikon, the closing share price of $352.08 on June 16 implies a forward price-earnings ratio of 27.71. In comparison, the five-year average multiple is 16.42. From a historical earnings multiple perspective, shares are significantly overvalued. A value investor with a low risk tolerance might not be comfortable initiating an investment in Apple at these prices.

A growth investor, however, might still find Apple an attractive play considering the massive leeway for growth available as the tech giant makes inroads into other business sectors. The price-earnings ratio will decline dramatically if it can beat revenue estimates and improve earnings per share at a faster clip than analysts and investors are factoring into their models. According to company filings, it has ample liquidity with $94 billion in cash. This will prove to be a catalyst for growth as Apple can and will make the most of its financial strength to tap into new markets and business sectors. An investment in Apple will be a bet on the future of the company, which is quite uncertain at this points since it is in a transformation phase. If the transition to a business model with a focus on services is successful, Apple will reward investors handsomely for taking on the high risk.

Takeaway

While Buffett seems to be comfortable holding Apple even after the massive surge in the share price over the last couple of years, Ariel Investments' Rupal Bhansali thinks the stock is overvalued. In an article published in January, I discussed why she thinks the best decision would be to short the stock. A closer look at the prospects and risks reveals Apple might still be a good investment for growth investors, but not so much for value investors as there is a significant degree of uncertainty involved.

Disclosure: I do not own any stocks mentioned.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

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