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Standard & Poor's


09/24/15 05:00:13 PM


We are upgrading shares of Apple (AAPL 116*****) as we now believe the risk/reward on the shares are compelling over the next 12 months. In this piece, we highlight reasons for our more positive outlook on the shares. We maintain our 12-month target price of $150, which implies more than 25% upside to the current shares.

We believe the emergence of leasing programs is a notable positive for the company as it helps reverse a major trend and will help provide support for iPhones in a tough year given year-over-year comparables. Our view was that the removal of two-year contracts would result in consumers holding onto smartphones longer, thus extending the average life of a device, as mobile phones become more commoditized. While AAPL's leasing program is unlikely to drive much additional demand, we believe it is having a direct effect on carriers as the likes of T-Mobile have already begun to offer new more attractive programs than AAPL's iPhone 6S/Plus program, which starts at $32. In actuality, we believe this is the best case scenario for AAPL and we believe will help drive higher anticipated demand for next generation devices in the future.

We now believe potential downside to consensus estimates for FY 16 (Sep.) appear less likely. Our biggest fear over the next year was that selling prices would be unsustainable and potentially below consensus following the ramp of the iPhone 6/Plus. The reason is that we would see an unfavorable shift towards the iPhone 6/Plus devices as prices decline and the phones remain popular given anticipated minimal enhancements to the "S" version. However, we believe the emergence of leasing programs will help promote demand for the next generation "S" version devices, thus supporting selling prices. We think an increase in revenue for iPhones in FY 16 is now attainable.

We believe initial weekend sales of the iPhone 6S/Plus will act as a positive catalyst. AAPL has already stated that pre-orders for the iPhone 6S and iPhone 6S Plus has been strong and is on pace to beat last year's 10M unit first-weekend record. We believe these sales should be easy to attain given the fact that sales for the iPhone 6/Plus last year could have been significantly higher than 10M given supply constraints, in our view. We also note that China is included on the list of countries that can purchase the device in the initial weekend whereby that was not the case last year. The fact that the iPhone 6S/Plus is being launched about a week later into the September quarter than was the case a year ago should also act as a tailwind in the tough comps December quarter.

While Apple TV and the Apple Watch are small contributors to revenue at the present time, we believe both have the potential to be important drivers 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 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. After last week's event that showcased potential Apps like AirStrip (Patient Monitoring), we believe AAPL has the potential to make significant inroads in the Healthcare space. Despite our favorable expectations on Apple's living room and wearables initiatives, we are less optimistic about the iPad. We believe the recently released iPad Pro will help give AAPL a product to penetrate into the enterprise space. That said, we are not convinced about the higher-priced iPad Pro being a game changer for AAPL in the tablet category and we see the best case scenario being revenue stabilization in the space.

We estimate operating EPS of $9.11 in FY 15 (Sep.), $9.69 in FY 16, and $10.94 for FY 17. 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 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.


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