Apple (AAPL) is Set-Up Perfectly to Surge this Cycle, Morgan Stanley Says

August 19, 2014 10:03 AM EDT
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Price: $120.00 +0.18%

Rating Summary:
    60 Buy, 10 Hold, 5 Sell

Rating Trend: Up Up

Today's Overall Ratings:
    Up: 30 | Down: 30 | New: 23
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Apple (NASDAQ: AAPL) shares are modestly higher (+0.6%) early Tuesday but are getting ever closer to the $100 level and a new all time high ($100.72). Part of today's upside comes on the back of positive comments from Morgan Stanley analyst Katy Hubberty. They analyst said the stock has a better set-up than in 2012 given low institutional ownership, increased cash return, stronger/broader management team, increased M&A and R&D, stabilizing margins, and higher contribution from services They are recommending adding to positions into the iPhone 6 + iWatch product cycles.

The low institutional ownership makes the stock set-up attractive, according to Hubberty. "Even after the recent move in the stock, the top 100 institutional owners of AAPL shares hold a 2.3% position in their portfolios on average as compared to 4.5% at the prior peak in 2012," she notes. "This is well below AAPL's S&P 500 weighting of 3.4%. Further supporting the stock, earnings estimate revisions recently turned positive, which we believe will continue post the launch of iWatch, and the company recently stepped up cash return for a total (dividend + buyback) yield of 8.5% in FY14."

The analyst also said the company's leadership and product investments shouldn't be ignored. "After improving the executive leadership team - e.g. Angela Ahrendts as head of Retail and Online Stores - and adding well over a dozen leaders in key areas of competency, including fashion, medical research, digital content & marketing, and wearables, we believe CEO Tim Cook now has the bench in place to execute on new product categories," the analyst said. "This compares to the 2012 share price peak, when the leadership team had yet to undergo any meaningful change. What's more, FY14 M&A spend so far is up 7x vs. FY13, and R&D growth will accelerate to 60% Y/Y in F4Q14, both signs that Apple is working to extend iOS beyond iPhone/iPad. In particular, we believe iWatch is an underappreciated market opportunity with the potential for up to 60M shipments in the first year."

The analyst also highlights that when it comes to margins, mix is on Apple's side this cycle. "As compared to margin compression early in the 2012 iPhone 5 cycle, we see several reasons for continued gross margin stability. 1) Due to App Store becoming a greater % of revenue, Online Services (iTunes + App Store) revenue is now accretive to corporate average margins and total company growth. 2) iWatch gross margin at 40%+ should have a positive impact compared to the negative impact of iPad Mini. 3) Warranty expenses as a % of revenue are now declining Y/Y, which should continue, helped by an easy compare this quarter. 4) We expect Apple to pass through higher iPhone 6 bill-of-material costs in the form of either like-for-like price increases or mix shift to higher NAND (e.g. by holding back low-end NAND option early in the cycle, similar to iPhone 5C)."

The analyst reiterated an Overweight and price target of $110 on Apple.

For an analyst ratings summary and ratings history on Apple click here. For more ratings news on Apple click here.

Shares of Apple closed at $99.16 yesterday.

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