Apple: Grinding Its Way Down (NASDAQ:AAPL)

Apple inc. (NASDAQ:AAPL) investors are likely looking forward to the global developer conference, or WWDC, in June, when the company is expected to unleash its long-awaited mixed reality device.

Before anyone gets too excited about Apple’s “moonshot” attempt at the AR/VR Space, Meta Platforms, Inc. (META) just lowered it price tag for its Oculus devices.

Meta is determined to lead this space and likely wants to bolster its first-mover advantage against Apple’s imminent foray. It suffered greatly at the hands of Apple’s ATT, as CEO Mark Zuckerberg saw META experience its worst downturn in recent times.

Additionally, Apple’s first mixed reality device, which is expected to cost between $3K and $5K, is likely aimed at professional users, suggesting that enthusiasm over initial adoption should be moderated. With Apple’s supply chain partners expecting 1.5 million shipments in the first period year, Apple could achieve sales of just $6 billion. Compared to Apple’s FY23 revenue estimates of $389.2 billion, this represents a share of about 1.5%. Is it more hype than reality? Investors are urged to exercise caution.

Wall Street analysts have high hopes for Apple’s ability to drive subscription and service growth to justify its current consensus price target, or PT, of $168.4.

Apple bull Morgan Stanley (MS), which has an above consensus PT of $180, foresees that the health of its services business could support Apple’s recovery. It emphasized:

Meanwhile, Apple’s services business is expected to return to double digital revenue growth in fiscal years 2023 and 2024. That performance will be driven in part by a new acceleration in app store popularity, price increases and easing headwinds related to foreign exchange. Those price increases were seen in products such as Apple Music, Apple TV+, Apple One and international apps. – CNBC Pro.

Investors should ask themselves whether that statement is realistic? Why is Morgan Stanley so committed to growing services? Investors should note that the services segment is Apple’s top driver of earnings, with an average estimated EBIT margin of 66%, well above iPhone’s average estimated EBIT margin of 25%.

Enthusiastic investors should remember that Apple has an EBIT margin profile of 30.7% in its most recent quarter. Therefore, it is easy to see why MS sees the reacceleration of Apple’s services business as crucial to an upward revaluation.

However, average analysts’ estimates suggest Apple’s FY23 operating EBIT growth could decline, down 5.9%, based on a 1.3% decline in revenue.

In addition, Trefis’ sum-of-the-parts valuation, or SOTP, suggests that Morgan Stanley could be overly optimistic as service revenues are expected to grow 8.5% in 2023.

Therefore, we believe investors should be cautious in expecting the high-margin services segment to drive double-digit growth to mitigate the slowdown in iPhone shipment growth.

Apple’s Android competitors will also be launching new premium smartphones to compete with the Cupertino company, shifting their focus away from their lower end segments.

Despite this, Apple’s grip on Gen Z is firm, suggesting that Apple’s installed base among younger consumers could help expand iOS market share over Android OS. So, as Apple expands its ecosystem of devices and works to leverage its massive installed base, it could help mitigate the slowdown in iPhone shipment growth.

But critical care has not changed. With analysts expecting the normalization of Apple’s services growth to pick up significantly over the next two years, we think the stage could be set for disappointment if Apple’s performance falters.

In addition, AAPL’s NTM EBITDA multiple of 18.5x has not resolved the headwinds of overvaluation, and is well above its 10Y average of 11.4x.

The price action of Apple Inc. also appears to be stagnant since the recent earnings release. Therefore, after January’s surge, sellers could continue to cash out and take profits.

AAPL has also made lower highs and momentum has weakened further.

The challenges discussed above, coupled with analysts hoping for a sharp acceleration in growth engines, are not constructive.

The reward/risk profile of Apple Inc. seems unattractive for buyers to consider. Sellers sitting on solid profits should consider taking profits and moving on.

Rating: sell (repeated).