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Standard & Poor's


10/05/15 10:00:02 AM



This week's Focus Stock of the Week is Apple Inc. (AAPL: $110.38) which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. Apple is a leading provider of smartphones, tablet devices, computers and wearables. It also sells a variety of related software, services and accessories. Our Strong Buy recommendation reflects our view of AAPL's compelling valuation, our favorable view on leasing programs by carriers/AAPL and positive outlook on potential products offerings in calendar year 2016 (i.e. new iPhones and TV streaming).

We project 4.4% revenue growth for FY 16 (Sep.), following our projection for a 28% increase FY 15. AAPL's success with large screen iPhones, which recently comprised 63% of sales, is helping the company to capture share at the high-end of the smartphone market. We expect demand for the iPhone 6S and 6S Plus to be healthy, supported by robust demand in China. We believe the recent emergence of leasing programs (AAPL announced plans to lease devices during its September 9th event) is a notable positive for the company as it will help shorten the replacement cycle of an iPhone device and could provide a recurring revenue stream over time. We believe AAPL's leasing program is also having a direct effect on carriers, as the likes of T-Mobile and Sprint have already begun to offer new more attractive programs than AAPL's iPhone 6S/Plus program. We believe this endeavor will help drive higher anticipated demand for next generation devices in the future. We believe the biggest enhancements to AAPL's newest iPhones (6S and 6S Plus versions) include an improved 12-megapixel camera, 3D Touch technology, faster A9 processor, and new rose color option. We note that at the end of the June quarter, only 27% of AAPL's existing subscriber base had migrated to the iPhone 6/6 Plus, paving the way for ongoing momentum for its next generation model.

We believe Mac sales, which comprise about 12% of total sales, will remain steady. While this business has declined in importance, given the success of the iPhone, we believe Mac's are performing very well given the steep declines being witnessed across the rest of the PC category. For iPads, about 9% of sales, we see revenue growth remaining elusive due to the more mature nature of the space and the fact that higher Phablet sales are cannibalizing the business. Although we believe the upcoming release of the larger screen and much pricier (starts at $799) iPad Pro (begins shipping in November) will help give AAPL a product to penetrate into the enterprise space, we are not convinced about it being a game changer for AAPL in the tablet category. We see the best case scenario being revenue stabilization in the space.

While Apple TV is a small contributor to revenue at the present time, we believe it has the potential to be an important driver to growth over time. We believe AAPL is evolving its offerings in the living room and positively view the development of a tvOS (TV operating system) in conjunction with the new set top box announced on September 9. We expect more great things to come from AAPL in this arena over the next two to three years, with potentially a TV streaming service (most likely a calendar year 2016 event) and eventually an actual TV offering in the company's future plans.

On the Watch front, while sales thus far have been mixed, we remain bullish on the long term prospects for the category. We see the second and third iterations being much more successful as the company has now allowed for applications to be created "natively" and has made the sensor available to developers. Specifically, we believe AAPL has the potential to make significant inroads in the Healthcare space. Revenue from the Watch, TV set top box, iPod and other services combined to represent 16% of sales in the most recently completed quarter.

We estimate operating EPS of $9.11 in FY 15 (Sep.), $9.69 in FY 16, and $10.94 for FY 17. We anticipate modest share repurchases and expect iPhone prospects to remain the key driver to revenue/earnings growth in the foreseeable future.

Our 12-month target price of $150 is based on a P/E of 15.5X our FY 16 EPS estimate, above hardware peers, but near the S&P 500 Technology sector. We also note net cash per share of over $25 and robust free cash flow generation. With shares currently trading below 10X net cash to our FY 16 estimate, we think AAPL's valuation is extremely compelling.

Risks to our recommendation and target price include softer than anticipated end-market demand, greater than expected pricing pressures, competitive handset and tablet offerings gaining traction and less success with future product launches/innovations.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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