Historical Performance

Revenue & Cost Drivers – How is the money flowing in and out?

As I mentioned above, Apple’s revenue can be split into two broad categories: Products and Services.

In 2021, Products made up 81% of the sales for the company, with the rest coming from services.

If we look deeper into the product revenue split for its second-quarter results of 2022, 65% of the product revenue comes from the iPhone alone, with the rest fairly evenly split amongst the other three categories. In other words, despite a large portfolio of products, the group still generates the majority of its revenue from its mobile devices.

Looking over at the costs, overall, the products’ gross margin is 35.3%, and the services’ gross margin is 41.8% as of the end of 2021.

Looking at the detailed cost breakdown for last year reveals some useful insight.

COGS: $152,836, 42% of revenue

R&D: $21,914 6% of revenue

SG&A: $21,973 6% of revenue

The biggest outflow of capital is the Cost of Goods Sold. That’s all the costs for manufacturing, designing and selling the products and the services. And with the price of raw materials, especially battery metals, on the rise, margins could come under pressure.

It’s encouraging to see the business reinvest in itself through research & development. After all, since this group lives and dies by its technology, Apple needs to stay ahead of the competitive curve from an innovation standpoint.

Fundamentals – How do the financials look?

Below is the four-year trend of Apple’s revenue stream. Despite the pandemic, the company has grown revenue by 38% over the last four years. In my opinion, that’s impressive. And this growth has led to a whopping annualised revenue stream of $368bn!

A similarly encouraging sight is the firm’s gross margins. Over the last four years, they’ve hovered between the range of 38% to 42% staying relatively stable.

Considering raw material prices have been climbing during this time, it suggests that Apple is either passing on additional costs to customers or has found a way to eliminate redundancy in its manufacturing pipeline.

Either way, it’s a sign of shareholder value creation in my eyes. So it’s not surprising to see operating profit margins and net profit margins stand between 27% to 30% and 23% to 26%, respectively.

As of 2021, the company has $34bn of cash on its balance sheet and a debt of $124bn. Another key figure is the $127bn of marketable securities that sit on non-current assets. This is essentially Apple’s hedge fund. Therefore, the company can easily pay off debts with cash and marketable securities.

The free cash flow has continued to grow over the years and now stands at $92.9bn and has been above $50bn for the last four years. Therefore I think it’s safe to say that Apple will continue to be a free cash flow machine for the foreseeable future.

Management – Who’s running the show?

The company is now run by Tim Cook, who has been running the company since 2011, when Steve Jobs, the iconic Apple founder, passed away. Despite the uncertainty at the time, Cook has proven himself to be a valiant leader with the stock delivering ten-bagger returns since he took the corner office.

Tim has focused on strengthening the product line of Apple with accessories like the Apple Watch and also Airpods, both category leaders. He also developed a strong services business that contributes 20% of revenue annually and a third of the gross profits.

In 2021, Tim Cook received $98.7 million in a total compensation package. Needless to say, that’s an enormous sum of money. But what I find reassuring is that $82.3m of this is in stock awards based on long-term business performance milestones. From what I’ve seen, this further aligns with the interests of shareholders and management. And is a recipe for long-term success.

He is not short of money and clearly focused on making an impact. His management style allows project leaders to build their own teams, support them, and not rush product launches. An easy thing to do when you are generating the cash flow Apple does.

Timothy Cook

---

CEO

61 Years Old

$15m Salary

Owns <0.01% of Shares

Competitive Advantages – Why will it beat its rivals?

Apple is one of the few companies that has a plethora of competitive advantages that make it such a strong business in my eyes. And with such a wide moat, it’s not surprising to see it become one of the biggest companies in the world with a $2.35trn market capitalisation!

While the firm has undeniably fierce competitors, years of pursuing quality and effective marketing strategies have generated an exceptional brand. As such, it commands a significant level of pricing power expanding profit margins in the process – something that’s proven useful in the current inflationary environment.

A big driver of the group’s success is the creation of an ecosystem. After purchasing a product, the group is able to easily upsell its other offerings like AppleCare services or accessory devices like AirPods, the iPad, or Apple Watch.

This continuous stream of buy then buy again ends up generating a significant network effect. With the number of Apple users increasing every day, the attractiveness for developers to create new applications for Apple products increases. With more capabilities, more users are brought into the ecosystem, and the cycle repeats itself. To top that off, since these applications usually end up being distributed through the Apple Store, the company generates even more income from transaction fees.

In the mobile market, Android devices still dominate with a global market share of 72% versus Apple’s iOS’ share of 27%. But that is up from 19% in 2017, indicating that management is making the right moves to steal market share and expand its growth potential.

Whether this trend will continue moving forward has yet to be seen. But personally, I’m cautiously optimistic, providing that the group doesn’t become complacent as so many other industry titans have done in the past.

Risk Profiling – Where are the weaknesses?

Valuation & Forecast – Is the price right?

Apple seems to be a high-quality company with good growth prospects, in my opinion. But is it worth buying at the current share price?

I built a discounted cash flow model to estimate the fair intrinsic value of this business with a few assumptions. Firstly, I’ve predicted that revenue in 2023 will land at $449bn and will continue to maintain a 10% annualised growth rate for two years before linearly decaying towards 5%. I’ve also assumed that underlying profit margins can continue to be maintained at around 30% moving forward.

Pairing these factors with an 8% discount rate returns an estimated intrinsic value of $170.86 per share. Compared to today’s share price of $145.4, my model suggests that the stock might be undervalued by around 15%.

What’s the score?

Apple is one of the most well-known and loved brands in the world, with a very strong product line paired with a solid range of support services. There is no doubt that this company is a free cash flow machine – a useful trait to have in an inflationary environment.

Providing management can maintain its current performance, I believe the Apple share price can continue to climb to new heights. Even more so, given my valuation model indicates the stock is currently cheap. That’s why I’m considering this business for my portfolio today.

89 / 100

Disclosure

Imran Dean does not own shares in Apple Inc. Reasonable steps have been taken to ensure the accuracy of the information at the time of publishing. The views and expressions within this analysis are the opinions of the author. It has not taken into account the circumstances of any specific individual, and does not constitute personal advice or a personal recommendation for any individual; neither should it be solely relied upon by any individual when making an investment decision. The Money Cog has a disclosure policy.