Apple (NASDAQ: AAPL) fell by over 8.3 percent last week following the announcement on Tuesday, September 12th of its two new iPhone offerings, including the long-awaited new “low-cost” model. The sell-off could present an opportunity to buy if you believe the price drop is overdone.
However, this could also mean the negative sentiment that has plagued the company’s shares for much of its recent history is returning. One thing is certain: Wall Street is clearly concerned, indicated by the sell-off and cut to earnings forecasts.
The bears on Apple’s stock believe the misstep in the new iPhone offering are emblematic of strategic problems at Apple. Long-term earnings expectations have already fallen over the past 18 months and so far, the new iPhone launch appears to have lowered these forecasts even further.
All this said, Apple is expected to generate significant free cash flow and trades at reasonable multiples, provided forecasts hold. The stock closed Friday at $464.90 which is 10.9x FY14 consensus earnings and 7.1x TTM EV/EBITDA.
Did Apple’s New iPhone Strategy Fall Short?
Apple has established a pattern of announcing a new iPhone every two years and in between introduces an updated “s” model. Last year, the company introduced the iPhone 5, so last week, it followed up with the iPhone 5s. However, it also did something it had not done before: Apple also presented a model called the iPhone 5c instead of just dropping the price on the iPhone 5 and calling that its mid/low-priced option.
This is not a technology blog, but here is a quick summary of the iPhone 5s and 5c. The iPhone 5s, Apple's new flagship, has an updated processor, the A7 chip, is the first 64-bit smartphone, and comes in unique silver, gold, and space gray so others know you have the newest version.
It has also has something called the M7 chip for enhanced motion detection and offers an upgraded camera and fingerprint sensor for security. The price ranges from $199 to $399 with contract. The iPhone 5c comes in five colors and lacks the upgraded features mentioned for the 5s, but is priced from $99 to $199 with a contract.
A Chance to Boost Market Share
The new strategy could boost market share in the mid-range smartphone market. Historically, the price points for Apple’s new iPhone remained high, and the company would offer the previous version. In this case, it would have been the iPhone 5 at a lower price point.
Basically, it offered more price-sensitive consumers one-year-old technology at a price point similar to new mid-range Android OS (NASDAQ: GOOG) powered devices. With the iPhone 5c, this strategy changed. Apple now sells a slimmed-down version of its newer technology, at the discounted price. The new strategy can help Apple compete more closely with less expensive offerings that utilize Android OS.
Price is a Concern
However, the price point for the iPhone 5c is still too high according to many, and caused a cut to analysts’ sales forecasts for the second half of 2013 and all of 2014. Excluding a contract, it costs $549 in the United States and, importantly, $735 in China.
China, in 2013, became the world’s largest smartphone market and having more moderately-priced models is important to winning market share there. The iPhone 5c is priced too high for some in this market where mobile providers often do not subsidize the phone cost as in the United States. Initial reports show moderate interest in the 5c from consumers in China. Expectations, fueled more by the media than Apple management, had grown that Apple would have a true low-cost model and this new offering was supposed to make a splash into that market.
The new iPhone strategy is one that was necessary and probably good in the long-term for Apple’s sales and market share. In Apple's line of desktop and notebook computers, it has long had two product lines: a lower-priced line and its high-priced flagship products.
Its lower-priced line was still at the mid-range price point of desktops and notebooks as Apple is committed to providing quality products to support the brand's image. This is no different now in smartphones, and while the pricing could change, the introduction of the iPhone 5c gives Apple an entry into the mid-range market so it can better compete with Android OS devices, helping it maintain — if not expand — its market share over the coming years.
Upcoming Catalysts Could Be Positive for Apple’s Shares
When earnings estimates get cut, stocks go down. The stumble here by Apple caused a reduction in earnings forecasts and accordingly the shares followed suit. That said, some reports based on tracking positive versus negative online social media remarks suggest the market is warming to the iPhone 5c. The stock has priced in relatively low expectations, so a surprise when Apple announces its pre-order numbers could drive the shares higher.
Apple will also make an announcement regarding the iPad and Apple TV before the end of the year. It seems expectations around those events are also more muted than in the past. There is room for the company to positively surprise without having to totally knock it out of the park with these new product releases. It is possible these events could also act as positive catalysts for the stock.
Conclusion: Potential for Positive Catalysts and Valuation Support a Buy Thesis
Apple clearly stumbled last week, but with expectations around the iPhone 5c tempered, there is room for a positive surprise for its sales numbers. In addition, the company’s cash position ($146 billion in cash and investments) is strong enough to repurchase around a third of its outstanding shares.
As noted earlier, it trades at 10.9x FY14 EPS consensus earnings. But after adjusting for cash, it trades at just 7.5x. And Apple is not burning cash, but generating more of it. It has an active dividend and repurchase plan to return cash to shareholders.
Also, Apple trades at the same 10.9x FY14 earnings multiple as Microsoft (NASDAQ: MSFT), a firm that has had sluggish growth for the last decade and is in the midst of a risky refocusing/restructuring of the business. The valuation in combination with the ability to beat sales expectations for the iPhone 5s and iPhone 5c have a more positive reception from the Street for its new iPad and TV product could all drive the shares higher.
What are your thoughts on buying Apple after last week's sell-off?
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