Apple: Upgrading To Hold, We’re Now Less Negative (NASDAQ:AAPL)

We’re upgrading Apple Inc. (NASDAQ:AAPL) to a hold. We’re less negative on Apple now, as we think the stock has priced in most of the negatives from the Chinese central government banning iPhone use for government employees and potential share loss to Huawei’s Mate 60 Pro. The stock is down a little over 2% over the past month, underperforming the FAANG peer group and S&P 500 (SP500). We don’t think the stock has hit its infliction point, as the challenging macro environment will continue to weigh on sales in 2H23. The 2023 smartphone total addressable market (“TAM”) is still expected to contract -5-15% Y/Y revised down from 0-5%, and we don’t think the Wonderlust event lineup will boost sales materially. The good news is that we don’t see the underperformance continuing in 2H23; instead, we now see the stock being an in-line performer in the near term.

The stock has underperformed since our sell rating, up 1% versus the S&P 500 up by 8% during the same period. We still believe there is more weakness to be priced in, but don’t expect we’ll see another decline as steep as the drop from a 52-week-high of $198.23 to $174.

The following graph outlines our rating history on Apple.

All Eyes on China: Priced In?

The stock has dropped 8% since September 5th, when the public became hyper-aware of two China-related headwinds pressuring Apple: Huawei’s new Mate 60 Pro and China’s ban on iPhone use for central government employees. The former came as a surprise to the broader market as after the U.S. export ban, it was unclear that China’s SMIC (SMIC) could manufacture 7nm chips, nor was it expected Huawei would be launching a new phone with features comparable to the iPhone, similar pricing as iPhone and above average downloading speed days before the Wanderlust event. We think the Mate 60 Pro will likely pressure the iPhone share in the near term, but we think the impact it’ll have on iPhone sales is currently overblown. We’re also constructive on management, keeping pricing of the iPhone 15 lineup in the same price range, with the exception of the iPhone 15 Pro, which is $100 more expensive. Management’s pricing was intentional and reactive to the macro backdrop; we think management hopes the pricing will boost unit sales and counteract the challenging macro environment.

News of China banning central government employees from using iPhones at work also stirred investor panic. Itau BBA analyst Thiago Kapulskis estimates that the public sector in China accounts for 59M employees, of which he states 20% are iPhone users, so 12M iPhones and factoring in price and upgrade cycle, finds that the ban’s impact would be $2.4B annually. We’re cautious about estimating revenue on impact, as there are still multiple factors to the issue that remain unknown, including the purchasing behavior of these employees when it comes to electronic devices. The following outlines Apple’s net sales by reportable segment as of 3Q23 Greater China accounted for $15,758M. The full extent of the ban is unclear still, but we think the bulk of negative news has been priced in.

The Real Issue: Challenging Macro Backdrop

Apple’s iPhone sales declined severely this quarter, both sequentially and Y/Y; the quarterly results, combined with the broader picture painted by earning results across the industry, signal that the smartphone weakness is not over yet. While we think the Wonderlust event does well to tick all the boxes in terms of eco-friendliness, completed transition of Mac to Apple Silicon, and the new 15-inch MacBook, we don’t think it’ll be enough to drive customers to upgrade their devices under the current macro uncertainty.

Americans’ credit card debt surpassed $1T, interest rates are at a 22-year high and may edge even higher, and the global macroeconomy is under pressure; we think discretionary spending will tighten and see fewer customers opting for new products or product upgrades. The stock is down 2% so far today in the aftermath of the Wonderlust event. While trading after the event has been volatile historically, we think post-event iPhone sales will be lackluster compared to previous events.

Valuation

Apple is trading above the peer group on an EV/Sales basis. The stock is trading at 6.9x EV/C2024 sales versus the peer group average of 5.8x. On a P/E basis, the stock is trading at 26.5x C2024 EPS $6.78 compared to the peer group average of 25.7x. We think Apple’s valuation is unjustified, given the slowdown in growth. We still don’t see attractive entry points into the stock despite the pullback over the past month.

The following chart outlines Apple’s valuation against the peer group average.

Word on Wall Street

Wall Street is overwhelmingly bullish on Apple. Of the 42 analysts covering the stock, 31 are buy-rated, 10 are hold-rated, and the remaining are sell-rated. Wall Street’s buy-rating is unsurprising; the sell-side is constructive on Apple’s Wonderlust event launching the iPhone 15 and efforts to move more production from China to India. We think it’s too early to be bullish on Apple, given the current smartphone demand environment.

The stock is currently priced at $179 per share. The median and mean sell-side price targets are $200, with a potential 12% upside.

The following charts outline Apple’s sell-side ratings and price targets.

What to do With the Stock

We’re upgrading Apple to a hold. We think the stock has priced in the current headwinds from China but don’t see the stock outperforming in the near term. We continue to believe Apple is at a higher risk due to the worsening macro environment impacting iPhone sales. We recognize management’s efforts to improve unit sales by keeping the iPhone prices largely unchanged. Still, we don’t expect the new iPhone 15 lineup will be enough to incentivize customers to upgrade in the current macro environment. We expect Apple Inc. to be an in-line performer in the near term.