Krause Fund Research Spring 2015 Information Technology Apple Inc. (NASDAQ: AAPL) Recommendation: BUY Target Price: $149.37 April 17th, 2015 Analysts 52-Week Stock Performance Xiwen Liu Neil Zhang [email protected] [email protected] John Sheeley Chenyu Zhao [email protected] [email protected] Key Financials: Price: Current Price $ 124.75 Consensus 1yr Target $ 141.57 52 week Low $ 74.85 52 week High $ 133.60 Stock: Source: Google Finance Marget Cap (B) $ 726.64 Investment Thesis and Key Factors Shares Outstanding (B) 5.82 • AAPL outperformed both the NASDAQ index and its Liquidity: competitors including IBM, MSFT, and HPQ. AAPL’s stock Total Cash (B) $ 32.66 price has increased by approximately 70% over the past Current Ratio 1.13 year, as shown in the chart above. Asset Management: • This robust growth was strengthened by AAPL’s A/P Turnover Ratio 0.08 continuous research and development. NI over R&D Profitability: expenses for AAPL was 6.54 during FY2014, much higher Profit Margin 22.25% than MSFT’s 1.94, and HPQ’s 1.45. Return on R&D 6.54 x • The newly-released Apple Watch and the new MacBook ROA 15.22% are expected to contribute to AAPL’s revenue growth. Unit ROE 35.15% sales of the Apple Watch is expected to grow by 250% in Financial Leverage: the upcoming year, as discussed in the “Revenue L-T D/E Ratio 0.26 Decomposition” section. Interest Coverage Ratio 53.67 • Seeking technological integration has allowed AAPL to Payout Policy: continuously expand its market. Apple Car Play, an auto Dividend Payout Ratio 28.68% entertainment system platform is regarded as an initial Forward Annual Dividend Yield 1.50% step to enter the automobile industry. Apple Watch was Forward Annual Dividend Rate 1.88 developed with various integrated functions. AAPL’s Earnings Estimates recent acquisition of LinX, an Israeli superior sensor Ye ar 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E technology provider, also proves this. EPS $6.49 $6.87 $7.71$ 8.12 $ 8.19 $ 8.39 $ 8.44 $ 8.52 Key Risk Factors Company Overview • Interest risk affects AAPL’s interest income and expense. Apple Inc. designs, manufactures, and markets mobile It also affects AAPL’s investments. 100 basis point parallel communication and media devices, personal shift in the yield curve would result in a $3.4 billion computers, portable devices, in addition to related incremental decline in the fair market value of AAPL’s software, services, and accessories. The company investment portfolio. offers a range of products and services including • Foreign currency risk not only affects AAPL’s foreign iPhone, iPad, Mac, iTunes, Apple Watch, and so on. exchange futures and options, but also determines the revenue and expenses for AAPL’s global operation. Important disclosures appear on the last page of this report. 1 shown no significant negative effect. Since China does Executive Summary not disclose job reports like most countries, we drew a similar comparison using the ratio of job advertisements- to-applicants. Even though the growth of the Chinese We recommend Apple, Inc. (NASDAQ: AAPL) as a economy was slowing in the fourth quarter of 2014, the BUY. AAPL’s current stock price is $124.75, and we job advertisements-to-applicants ratio rose to 1.15, up valued a weighted average target price of $149.37. It is from 1.09 last quarter.XIX The ratio indicates the hiring is common that a professional investor requires a 10% to still strong when the growth in the job market been 15% potential growth when he or she makes investment declining. Meanwhile, urban disposable income in 2014 decision. Since Technology sector is exposed to dropped 0.7% from 2013’s reading.XX A slight decline relatively high volatility and Apple faces significant of disposable income also indicates labor market has not interest rate risk and foreign currency risk. It is suffered from any major disturbances. reasonable for a sophisticated investor to demand a more than 15% potential growth in the stock price. Our We expect that the Chinese labor market will have an estimated intrinsic value is at $149.37, which is 19.74% abundant talent supply in the next 10 years. According higher than the current stock price. 19.74% would be to the 2010 population consensus report from Chinese convincing enough to issue a BUY rating. national Census Bureau, in 2020, 13.11% of the 2010 population will enter into the labor force while 12.01% Economic Outlook of the 2010 population will retire.XXI As the upcoming Chinese labor forces represent well-educated and open- minded young generation, we believe the next 10 year GDP will be the transition period of China. OBAOR is the One Belt and One Road project, a trans-Eurasian Since the technology sector has a very price-sensitive economic project aimed to improve the connection consumer base, we believe suitable economic conditions among Middle East, North Africa, Europe, and Europe will facilitate consumer electronics upgrades, leading to through building infrastructures that facilitate the trades higher sales of Apple product. Because the United States and creation of partnerships that enlist cooperation and China are two major markets that use Apple between nations. As Asian Infrastructure Investment products, we would like to analyze the future GDP for Bank gained support from 57 perspective founding the two areas. countries, we are confident about the future of the project, and we expect the project will improve We believe the United States economy will sustain its multinational trades and begin benefiting Chinese in current recovery over the next two years with an annual 2018. We project Chinese GDP will gradually slowed to GDP growth rate slightly below 3%. Surprising non- 6.2% in 2017 and will have an era of above 6.5% growth farm payroll improvements at the end of last year, raised again in the following 8 years. economists’ hopes for the future outlook of the U.S. economy, but the strong trend does not last. Although economies continued to lower non-farm payroll expectations and had a forecast of 247,000 in March, they were shocked again as the report showed only a job increase of 126,000, almost half of what was expected. We has seen softening in hiring. Even though a strong US dollar is considered as weather effect, as the global economic conditions are problematic, we do not believe U.S. will have strong GDP improvement in the near XVIII terms. We believe GDP goes through cycles and therefore expect the global economic condition will recovers in 2017, leading to GDP an era of above 3% growth. XXIV Unemployment Rate Because of the steadily escalating level of economic reform, continued work force expansion and We believe the U.S. unemployment rate will be the key improvement, and the OBAOR (aka One Belt and one factor to drive U.S. consumer electronics consumption. Even Road) project in addition to China’s imitative on the though U.S. reports show improvements in labor markets, AIIB (Asia Infrastructure Investment Bank), our optimistic growth in real disposable income on a monthly sentiment on China’s real GDP growth over the next 10 basis, and a 50% decline in oil prices since last year, real years remains positive. While Chinese government has personal consumption has not increased as expected. We worked on policies for economic reform, reports have believe that paranoia from the 2008 recession led individuals Important disclosures appear on the last page of this report. 2 to repay their debts and save rather spending on discretionary In a Financial Times interview with China’s Premier goods and services. We expect that the unemployment rate Keqiang Li, Premier Li mentioned he is satisfied with the will be a strong indicator in determining consumer current value of Chinese Yuan relating to U.S. dollar, and confidence. If the U.S. unemployment rate continues to would not devalue Chinese Yuan to boost exports.XXIII improve, we believe individuals will be more comfortable Therefore, our 2 year projection of the CNY/ USD rate is borrowing capital and spending on luxury items, benefiting stable at around 6.2CNY/ USD. Apple. Consumer Confidence Interval As shown in the graph below, the Chinese unemployment rate in March of 2015 was 5.5 percent. Professional and As China and U.S. are two major markets for Apple’s business services, health care, and retail trade, are the major product sales, consumer confidence in both countries is drivers of employment.XXII Job cuts in the mining industry pivotal to Apple’s overall sales. The Consumer Sentiment offset the positive drivers. As non-farm jobs have shown Index, created by the University of Michigan, shows improving trends in the last 3 months, we believe that consumer optimism rebounded in the beginning of April. The employers will continue to create higher paying jobs in the average of the first four months of 2015 showed consumer next 3 months. Therefore, we expect the unemployment will sentiment significantly higher than the average of 2013 and decrease to 5.4% in April. Historically, the unemployment 2014. We believe that, as the U.S. economy continues to rate went as low as 5% in 2005, and continued to decrease as improve, the U.S. consumer confidence will continue to low as 4.4% in October of 2006. We project the improve. We expect the index to reach 98 index points in unemployment rate will continue to improve in the next two 2017. year and will remain as low as 5%. XXIV XXIV The Chinese consumer confidence is developed by China Exchange Rate National Bureau of Statistics.