Apple In Wonderland: What's Up With AAPL and the Fed?
'But I don't want to go among mad people,' Alice remarked.
'Oh, you can't help that,' said the Cat. 'We're all mad here. I'm mad. You're mad.'
'How do you know I'm mad?' said Alice.
'You must be,' said the Cat, 'or you wouldn't have come here.'"
-- Lewis Carroll, Alice in Wonderland
I'm struck these days by the duality of investors' deranged acceptance of current monetary policy as the norm and the herd's brainless bullish consensus on Apple (AAPL) and its share price and future profit prospects.
Let's look at both in greater detail:
Monetary Policy in Wonderland
Non-thinking consensus is the norm these days. And when combined with the dirty investment water provided by central banks' monetary policies (i.e., "money for nothing"), the crowd is beginning to resemble the Mad Hatter from Alice in Wonderland.
Subscriber "BadGolfer22" perfectly captured the market's zeitgeist and monetary insanity a few weeks back when he wrote:
"You know I think there are gonna be history books written about this period that rational people will read at some point, and I think just one of many idiocies that will stand out will be this irrationality in the marketplace. They are gonna ask this question of economic historians with complete bewilderment in their voices:
'Professor Jones, did investors really invest in bonds of basically bankrupt countries that printed money to make interest payments and to buy bonds they just issued in failing currencies, which allowed for more bond issuance due to more spending and debt issuance? And not only did they not get interest for doing so, but paid said governments for the right to do so? Did this really happen?? Did they really invest a million only to get back 975,000 10 years later? Sir, I just can't believe that. Were investors really that stupid? Where did they teach this?'"
Two decades from now, we'll likely look back at 2000-2016 monetary policy with disbelief that investors swallowed and accepted it.
As my friend Mark J. Grant wrote on Monday, it's almost as if we all now reside in Alice In Wonderland:
"'The White Knight's walking backwards and the Red Queen's off her head.' We ignore it mostly. What can we do about it anyway? We have absolutely no control over the antics of the central banks. In fact, a lot of investments are made just by trying to outthink what these people might do next. Move your rooks first.
'Take some more tea,' the March Hare said to Alice, very earnestly.
'I've had nothing yet,' Alice replied in an offended tone, 'so I can't take more.'"
Apple in Wonderland
Apple is another case of senselessness and delusion.
As of last Friday, 44 out of 50 analysts had "Buy" ratings on the stock, while the average price target is more than 40% above AAPL's current price. The crowd thought the quarterly results that Apple reported last night would be slightly disappointing, but that the stock was still a long-term buy all the same.
The "talking heads" that CNBC and Bloomberg TV paraded yesterday ahead of Apple's earnings release sounded more like the Mad Hatter than objective purveyors of facts and opinion as they rationalized the irrational. Off with their heads!
Only a few contrarians stood out, and frankly, I'm proud that I'm one of them. I've long written that I see "Peak Apple," and noted yesterday that the iPhone's product cycle islengthening and that average selling-price assumptions and margin forecasts have tocome down. Consensus 2017-18 estimates are far too optimistic.
Apple's results were profoundly disappointing to the bulls. Profits and EBITD margins were both weak, while forward guidance was even more disappointing. After-hours trading wiped out more than $40 billion of equity value overnight, and analysts will now lower their profit expectations for the company.
AAPL's two largest markets showed the most weakness. Chinese revenues fell 26%, while U.S. sales dropped 10%.
True, Apple was facing comparisons with a year-ago period that saw enormous pent-up iPhone 6 growth because of the introduction of larger screens. But the lack of any future "must-have" innovations will weigh on sales in the quarters ahead. As I've suggested in my diary over the past year, this will serve to lengthen the iPhone's product-upgrade cycle.
Unfortunately, Apple's explanation last night of iPhone-sales weakness wasn't sufficient. In fact, it sounded similar to claims by Intel (INTC) about that company's plans to lay off 11% of its workforce.
INTC said the cutbacks are coming because the company misforecast personal-computer demand for the fourth time in five years. Well, memo to Apple CEO Tim Cook: The high-end smart-phone market is maturing.
As I wrote earlier this morning, it seems like many investors are living in Apple in Wonderland these days.
Despite what the AAPL bulls say, the tech giant faces all sorts of problems.
For openers, Apple is levered to its product cycle -- and in all likelihood, the iPhone 7's introduction (the company's next important upgrade) will be a disaster.
After all, the iPhone 7 doesn't seem to have any important new features that will accelerate customer upgrades. (And Apple has basically guaranteed little consumer interest by leaking all of the iPhone 8's specs.)
AAPL also basically had just one chance to boost sales by increasing the iPhone's screen size, and that's already happened. Any new features that Apple seems likely to add in the foreseeable future are already available on rival phones that sell for less than half of what an iPhone costs.
Meanwhile, Apple Pay and the Apple Watch have failed to move the revenue needle much for a company with $200 billion in annual sales. And as I've written previously, I see no other new products over the near term that appear likely to do so, either.
Other issues I see for the stock:
* Apple is levered to global economic growth, a variable that I'm not encouraged by (as you can gather from my commentary over the past six months).
* Management concerns could surface. For example, major insider selling recently by the company's chief operating officer, chief financial officer and others should raise analyst questions. Executives don't blow out their stock in the belief that the company is facing just one soft quarter.
* Supply-chain figures are deteriorating for most of the company's products, from the iPhone to the iPad to the Apple Watch. (See earnings reports and commentary from Glenn, H&M Global, Rosenblatt and JBL.)
* There are signs of heavy product discounting in China. I've seen reports on new low-end phones appearing at lower-than expected price points, as Apple has to sell more than 50% more units to make up for iPhone 8s. AAPL also recently cut the Apple Watch's price.
* Innovation is slowing and competitive threats are mounting. The latest new-product launches represent a good example, but even last year's launches weren't very impressive. The iPhone 7's upcoming launch will likely be a non-event at best. Checks point to Samsung's new phone taking market share away from Apple's wares.
There are also potential signs of desperation in the fact that Apple is trying to get into the content game (a bit late to compete in a very crowded space). As online trade magazine9to5Mac.com recently reported:
"Apple has long been rumored to be creating its own original TV content, and now it's made its first plans official. Apple shared today that it will work with TV executives Ben Silverman and Howard T. Owens, as well as rapper Will.i.am on its first TV project (via The New York Times). Silverman is perhaps best known for his work on shows like The Biggest Loser, while Owens is one of the minds behind MasterChef Junior."
Finally, software bugs are appearing with greater regularity. Apple's support forums are currently swimming with complaints from iOS 9.3 users claiming that the company's latest software update effectively broke their ability to click on and open Web links.
The Bottom Line
Most analysts will materially reduce their 2016-17 Apple earnings forecasts today, while many will downgrade that stock. (Goldman Sachs has already taken Apple off of its "Conviction Buy" list.)
But my core investment thesis remains intact: It's unlikely that Apple's profits will exceed peak 2015 levels for years to come.
Of course, the bulls will emphasize the increased buyback authority announced yesterday, but isn't that further confirmation of "Peak Apple"?
I've been expressing concerns this morning about Apple (AAPL) and last night's earnings (click here and here to see my earlier missives).
I'd like to wrap up my thesis for the stock by talking about AAPL's huge, well-known cash position.
While Apple bulls often chortle about the company's $152 billion in net cash (many observers fail to subtract AAPL's debt load from the firm's $230 billion in gross cash), that has less utility than meets the eye.
After all, we're living in a time when Apple could simply borrow money at close to 0% interest in Europe and Japan and generate an approximately 20% return on investment by repurchasing shares.
And as I've previously emphasized, Apple would also have to take a large tax "haircut" to bring its cash back to America, as much of the money resides overseas.
Lastly, should the company continue to buy back Apple stock, its cash position will shrink. As I noted yesterday:
"Who Cares If Apple Has Lots of Cash?
The "Apple has a large cash hoard" argument falls short on several fronts to me.
First, as I wrote previously, AAPL's net-cash levels are flat-lining. As I noted: "Several commentators have mentioned recently that Apple has over $200 billion of cash. While that's factually correct, we should look at cash net of debt -- which in Apple's case has been flat-lining for a long time (principally due to share buybacks)."
And more importantly, every dollar of Apple's cash that's overseas has nowhere near $1 of worth to shareholders, as it faces U.S. taxes if it's repatriated to America.
As I wrote a few weeks ago:
"Security Analysis 101 teaches that investors shouldn't give a company 100% credit for cash held in the United States -- and certainly not for cash mostly held abroad, as is the case with Apple. There are all sorts of issues associated with cash: tax, debt, etc.
Here's my question: If Apple's balance sheet were a public company, what would you pay for it? In that case, it wouldn't be that much different from a shell company with $100 million in net cash (most of it overseas).
To me, the answer is about 50 cents on the dollar -- if that much."
--- AAPL's Last Important Phone Upgrade Cycle Augurs Poorly, Doug's Daily Diary (April 26, 2016)
The Bottom Line
"'Well, I never heard it before,' said the Mock Turtle, 'but it sounds uncommon nonsense.'"
-- Lewis Carroll, Alice in Wonderland
Apple was selling for only about 5x its trailing-twelve-month EBITD as of yesterday's close, in line with "old-economy" companies. It's doing so because it's now a mature old-economy company itself.
That's why my advice is that you sell or short Apple, but don't buy or hold the stock.
Investors have truly joined Alice in Wonderland when it comes to skepticism regarding Apple's maturing business profile. We're living live in a world of "uncommon nonsense" -- and while it's been quiet at Alice's tea party for the moment, I don't think it will stay that way for long, as there's danger at the door.
To quote The Grateful Dead:
"Well the first days are the hardest days,
Don't you worry any more,
'Cause when life looks like Easy Street,
There is danger at your door.
Think this through with me,
Let me know your mind,
Wo, oh, what I want to know
Is are you kind?"
-- The Grateful Dead, Uncle John's Band
