Wednesday, August 26, 2015

Time to Bargain Hunt with Apple - or Time to Wait on the Sidelines?

I've seen a lot of investors doing some unwise things during this market thrashing, as they're already calling to search for undervalued stocks to take a position in. Some with a position in Apple (AAPL) are pushing for an immediate increase in the number of shares acquired because of the recent correction.

Yet the fact Apple has been under pressure since the latter part of April, falling about 14 percent since that time (about 19 percent in the last 3 months). Economic news from China since then has not been helping the prospects for the company. It appears it is premature to add to a position in Apple.

On Monday Apple fell to under $95.00 per share, which prompted CEO Tim Cook to take to contact Jim Cramer to reinforce his view that the company has been doing well in China during the last couple of months, even though China's market crashed and exports have plummeted by over 8 percent. When I heard that, it made me question whether or not Cook could get into trouble with the SEC for taking that action.

The fact Cook felt the need to do this during a quarter definitely points to his concern Apple shares could take a beating, which even if unwarranted, could take time to recover from. That would also be exasperated by a earnings report that underwhelmed investors during the current quarter.

Even though some investors probably did well for an entry point Monday, it was luck that brought it about. We shouldn't be rolling the dice with our capital, and in my view we need to wait before seeing where this market and economy is going.

Mood over Apple

When talking about the mood for investors over Apple, I'm talking outside of those that have such an emotional attachment it makes it difficult to bypass the rhetoric and get to the reality of how the company is being looked at.

In general, the outlook for Apple is weaker than it has been, with the majority of that coming from the perceived weakness in China and how that may affect iPhone sales in the future.

That came on the heels of a trend by Chinese consumers to upgrade from lower-price smartphone models to iPhones. With China driving so much of the attention, it was impossible for Apple to escape being lumped in with the Chinese economy.

When combining this recent negative outlook with the correction, it definitely will offer an opportunity for Apple investors to get in at a good price. The question is whether there is still more room for the share price to drop, or if it's at levels it is a good time to get in.

I'm not referring to attempting to time a bottom here, but rather referencing whether or not this is more of a longer-term trend, and what will happen to the stock if it underperforms in China during this quarter; no matter what Tim Cook says about its current performance in China. We need to see numbers, not cheerleading to be convinced.

If investors punish the stock again, it could result in shares leveling off and not returning to current levels for a prolonged period of time. Most of that will be determined by iPhone sales in China during this quarter, and how they measure against expectations.

Apple's performance

With Apple being Apple, it's going to rightfully get rewarded or punished on exceeding or missing expectations disproportionately to other companies.

So when it didn't meet expectations in the latest quarter, its share price was pushed down. That is especially true concerning China, which is considered the growth market for Apple.

While iPhone sales did well, generating unit growth of 87 percent, it wasn't enough to placate investors, who in many cases interpreted that as disappointing performance. Overall, growth in China for Apple was up 112 percent year-over-year, surpassing over $13 billion.

Because of sales slowing down below expectations, it's very probable the share price of Apple will fall further before convincing investors the performance of the company in China is more sustainable than believed. That convincing won't come from cheerleaders, it'll have to come from performance as reflected in the numbers.

Valuation

Before getting into the valuation of Apple, I do think for those willing to hold Apple for the longer term, current prices provide some safety for the reason the stock is undervalued in my view.

Having said that, valuating Apple has to assume whether or not one believes it will still do well in China over the long term. At this time investors aren't convinced, which is why the share price has been under pressure since the latter part of April, 2015. That's why I'm saying the next earnings report will be crucial to how Apple does over the next year or more, depending on what the numbers tell us.

My valuation is on the assumption iPhone sales in China will remain robust, with the rest of the company performing in line with expectations.

The 52-week high for Apple is $134.54, which it reached in the latter part of April. That represents a little more value than I assign to the company, but not too far off.

If you take away the disappointing iPhone sales in China last quarter, the 52-week high is a little strong. That has to be balanced with some other factors that I think aren't being attributed to its valuation as they should.

For example, Apple ended last quarter with a cash balance exceeding $200 billion after it paid out dividends and bought back a lot of stock. That means the company still has extraordinary ability to generate a lot of cash even when it doesn't meet expectations.

While investors attributed a lot of their valuation to iPhone sales in China, I don't think they took into account the amount of cash the company can still produce on a consistent basis. This is where the undervaluation resides, and where it could surprise to the upside if - and that's a big if - China iPhone sales meet expectations going forward. This is the key catalyst determining the value of the company in the majority of investors' eyes.

Apple should be valued in a range of $127.00 to $129.00 on its cash generation and removal of shares out of the market.

Since investors aren't valuing that in at this time, it offers an opportunity to get in a a very good price.

Conclusion

My concern about Apple isn't over its ability to sell iPhones in China, but whether or not it can meet the high expectations investors have of it there. Rather, my concern is how the share price will be punished the Chinese economy slows even more, which it already is showing signs of, and if Chinese consumers still have the confidence in the economy to spend on higher end items like an iPhone.

If data suggest the Chinese are slowing their upgrades to iPhones, along with first-time sales, this will be a difficult headwind to overcome, even if it isn't considered a rational response by other investors.

Why this is important in the current market environment for Apple, is if investors get in now without knowing which direction China's sales are really going as measured by expectations, Apple's share price could become range bound and drop further, which could lock up capital for a significant period of time.

China's economy is slowing. There is no doubt about that. Now it must be determined the impact that will have on iPhone sales as Apple attempts to further expand its market share there.

Valuations won't matter if investors don't see the overall pieces of the company forming a larger whole than believed. It looks like iPhone sales in China are the metric the vast majority of investors are looking at for Apple. So while it looks like a bargain at these prices, it may take a long time for that to be reflected in the share price if Chinese sales fail to meet expectations.

On the other hand, it could surge beyond the valuation I see the company at if it is able to beat in China.

There is too much volatility in the market now to take a position in Apple without it being a roll of the dice. It's highly likely the market gyrations are far from over, and if capital is invested without waiting, it's locked in without knowing how deep and long this correction is going to take.

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