To The Moon

Summary

• Apple's installed base grew by around 100% to 2 billion active devices as of end-Q1 FY 2023.

• A new mixed reality headset, a potential new iPhone subscription plan, and improved capital return are the three reasons to buy Apple's shares in my opinion.

• I stick with my Buy rating for Apple, as the multiple bullish factors for AAPL indicate that the stock deserves a higher valuation multiple.

Apple Faces Shortages In iPhone Supplies Amid Turmoil In China

Elevator Pitch

I have a Buy investment rating assigned to Apple's (NASDAQ:AAPL $Apple(AAPL)$ ) shares.

With my earlier article for AAPL written on January 10, 2023, I highlighted that Apple's stock was a buy on the dip. Since the publication of my prior update, the company's share price rose by +25.7% (source: Seeking Alpha price data), while the S&P 500 went up by +5.2% in the same time frame.

My latest write-up touches on the three key reasons for staying bullish on AAPL. The expected launch of the mixed reality or MR headset in mid-2023 could ignite investor interest in Apple's stock and expand the long-term addressable market for AAPL. Separately, Apple's potential introduction of an iPhone subscription plan will help to grow AAPL's recurring revenue streams and increase the average user spend over time. Lastly, AAPL is expected to continue returning a substantial amount of excess capital to shareholders in the future, considering its free cash flow generation profile and its policy of moving towards "neutral net cash."

AAPL Stock Key Metrics

The most important metrics for Apple relate to the company's installed base.

AAPL revealed at the company's Q1 FY 2023 (YE September 30) earnings briefing that its "installed base of active devices" increased by +100% over a seven-year period to 2 billion, which is equivalent to a CAGR of approximately +10%. In the past 12 months, Apple's installed base expanded by 150 million devices or +8% YoY, and the installed base for AAPL in certain high-growth markets like Brazil and India even grew by more than +10% in the past one year.

It is inevitable that some investors will focus their attention on Apple's YoY top line declines of -5.5% and -4.4% for Q4 FY 2022 and Q1 FY 2023, respectively. AAPL will witness weak product sales when its supply chain faces disruptions and demand is temporarily weakened during periods of slow economic growth. But as long as Apple continues to enlarge its installed base, it is reasonable to assume that the company's revenue and earnings will eventually follow a similar upward trajectory over time.

At its first quarter results call, Apple stressed that the company's growing installed base "represents a great foundation for future expansion of our ecosystem" and expands its "addressable pool of customers." In the subsequent sections of this article, I explain how Apple's installed base growth is closely linked to the key reasons for buying AAPL's shares.

Reasons To Buy Apple Stock

In my view, the three main reasons to buy Apple's stock now are the potential introduction of a iPhone subscription plan, the planned launch of new extended reality or XR products, and sustained shareholder capital return.

Potential iPhone Subscription Plan

An earlier February 12, 2023 Bloomberg article mentioned that Apple's "iPhone hardware subscription program" is expected to "still arrive eventually" despite potential "delays."

Many Apple iPhone users will typically include in their respective budgets a certain sum of money that is allocated for new model purchases. Assuming that AAPL does launch a iPhone subscription plan as reported by the media, this will allow iPhone owners to have greater capacity to spend more on Apple's other services and products. This implies that Apple's overall revenue can potentially grow faster, as users subscribes to more services and buy other ancillary products without having to fork up a meaningful sum of money for new iPhone upgrades every year. Also, an iPhone subscription plan will increase switching costs, and reduce the likelihood of current iPhone users switching to smartphones sold by other brands.

More significantly, I believe that Apple suffers from a valuation discount due to its dependence on non-recurring product sales. In FY 2022, AAPL derived 52% and 20% of its revenue from iPhone and services, respectively as per its 10-K filing. Other products contributed the remaining 28% of its top line in the recent fiscal year. If Apple can increase the proportion of its revenue earned from recurring sources (subscriptions and services) with an iPhone subscription offering, it will be easier for AAPL to command a higher valuation multiple.

New MR Product Launches

There is a frustration lack of innovation when it comes to smartphones. It is pretty common to hear from friends that the new iPhone (or any other branded smartphone) isn't that much different from its prior iteration. Unlike other technology segments which have seen increased investor interest in recent times due to new investment themes like chatbots, the smartphone space seems relatively "boring" in comparison. This has obviously capped the capital appreciation and valuation re-rating potential for Apple's shares to a large extent.

An earlier February 15, 2023 Seeking Alpha News article mentioned that AAPL's first "mixed-reality headset" might be introduced to the market in the middle of this year. Notably, Apple's CEO Tim Cook shared in a recent interview with GQ that he thinks mixed reality products "could greatly enhance people's communication, people's connection," and "empower people to achieve things they couldn't achieve before." It is clear that Tim Cook sees new mixed reality products as a game-changer for consumers.

It isn't just about the excitement with new products leveraged to technologies such as mixed reality. In quantitative terms, the potential of Apple's mixed reality headset and other related products is promising. Research firm Mordor Intelligence forecasts that the worldwide mixed reality will grow at a +41.8% CAGR for the 2022-2027 time frame. The consumer headset market is estimated to a $50 billion market by the end of this decade as per Globaldata's projections.

As a start, AAPL has the potential to generate around $3 billion revenue from its MR headset in the initial year of launch assuming a target of 1 million and an average selling price of around $3,000. Recall that Apple currently has an installed base of 2 billion active devices, so it won't be farfetched to see Apple's headset sales rise substantially in the coming years through active cross-selling.

Shareholder Capital Return

Looking ahead, Apple's installed base should continue to expand, and the company is well-positioned to increase average spending per user with the introduction of the iPhone subscription plan and other new products & services. This suggests that AAPL's recurring cash flow will grow over time, and I believe that this should translate into a sustained level of dividends and buybacks in the future. Apple delivered $111 billion in free cash flow for FY 2022 and the company returned $111 billion of capital to its shareholders in the most recent fiscal year, which is equivalent to a free cash flow payout ratio of 100%.

Apple had roughly $54 billion of net cash on its books as of the end of the first quarter of fiscal 2023. At its Q1 FY 2018 investor call in February 2018, AAPL disclosed for the first time that it was "targeting to become approximately net cash neutral over time." As per S&P Capital IQ's consensus data, analysts see AAPL's free cash flow increasing by a +10% CAGR from $97 billion in FY 2023 to $141 billion for FY 2027. Considering Apple's current net cash position and its expected cash flow generation for the years ahead, it is realistic to expect AAPL to continue returning substantially all of its free cash flow to shareholders.

Is Apple Worth Investing In?

Apple is a worthwhile investment, as I see the potential for AAPL to benefit from a positive valuation re-rating.

The market currently values AAPL at approximately 25 times forward FY 2024 normalized P/E, based on its last done stock price of $163.76 as of April 5, 2023 and its consensus forward FY 2024 EPS of $6.59.

I think that Apple could trade at a P/E ratio of 30 times or higher in time to come. A higher proportion of recurring revenue supported by product subscriptions, the venture into the mixed reality headset product category, and shareholder-friendly capital allocation policies are expected to be factors driving a P/E multiple expansion for AAPL.

Bottom Line

The market should award a higher valuation multiple to AAPL going forward, assuming that Apple maintains a steady level of shareholder capital return, and its new offerings and subscription plans are well-received by its customers. I continue to have a bullish view of Apple's stock.

Source: seeking alpha