Ex-Berenberg Analyst Ahmad is Back with a 'New' Sell Rating on Apple (AAPL)

Former Berenberg analyst, Adnaan Ahmad, is back at it on Apple (NASDAQ: AAPL). After getting fired recently, which may have had something to do with his controversial views on the iPhone maker, he started his own boutique. Today he issued a teaser note on his recent initiation report on Apple (Dated May 4, 2016).

Ahmad set his new rating on the stock with a Sell rating and $80 price target. This matches his last rating while at Berenberg, although the price target moves down from $85.

Below are some highlights from his report:

1) The debate right now is going to shift, it has to. No longer is Mr Market going to debate volumes and order push-backs in Apple’s Asian supply chain whether out of Murata in Japan or Hon Hai in Taiwan or LG Display in South Korea. Mr Market is now going to be squarely focused on gross margins and average selling price (ASP) development. Bulls will argue that the bar has been reset for earnings with a lower volume, ASP and gross margin trajectory than they had forecast at the beginning of the year. They will exclaim that Apple remains cheap and a value-play given that margins are sustainable at this lower level and that one should treat the stock as a bond and clip a coupon on an annual basis. My view is the opposite, margins and ASPs have only just started to get squeezed and as this persists, Apple’s value investors are going to start to question the underlying premise of their investment thesis, ie sustainability of margin structure - Carl Icahn is just the start......

2) Yes, Apple sub-$100, has a lot priced in, if one purely focuses on growth, that is. However the big questions are: Can Apple sustain 38-40% group gross margins and 40-45%+ iPhone gross margins? What happens to Apple's ASPs in the next two to three years? Will they go the same way as Nokia and Blackberry (Research in Motion) (see note attached)? Will Apple's over 3x ASP premium to the average smartphone price sustain? Will Apple be able to price the iPhone7 at a premium as it did the 6 (Me thinks not!)? Or was the 6, the big volume, margin and ASP super-cycle given it was a move to a big screen? (It certainly looks that way). What can the 7 have? Curved screens, better battery life, wireless charging – Are these really going to make a difference (Nope!)? I think the 7 is more likely to go the way of the iPhone5 cycle versus the iPhone6 cycle, ie a non-event! These are some of the key questions on the stock. There are many more (Is Apple losing share in China? (Yep) etc. Looking back at history (you all know I'm a buff), on when a company starts to face a growth question mark, does not bode well for Apple unless it comes up with a major new product category or as Tim Cook put it in on the recent earnings call “the future of Apple is bright….the product pipeline has amazing innovation ahead”. Time will tell but the clock is ticking…..Tim is saying “bright” and I am saying “rotten”!

3) I would also argue that Apple's iPhone gross margin rebound from the trough 36-37% level in 2013 to the 40-41% level recently had benefitted from a) a big volume uplift given the iPhone 6 super-cycle which resulted in leverage, b) a price hike for the new iPhone 6 products given increase in screen size and specs, c) warranty accruals which reversed from the 4% level to the 2% level, d) better component costs (look at NAND and DRAM pricing that have been clobbered in the past 18 months) and e) a robust product mix, more 6+ and higher GB than what the market had expected, a larger weighting of Appstore (better margins) and a lower weighting of iPads (worse margins). In addition, accounting changes to revenue deferrals (on the MAC and iOS) have also benefitted Apple recently.

On the flip side, its gross margin had been hit by the strong dollar. Moving forward, with demand tepid, Apple’s gross margin, in my view, is going to suffer from a) some of that leverage turning negative, b) mix to worsen (more SE and increased iPad), c) less benefit from warranty accruals and d) its FX hedges roll-over (hedging contract gains). Component costs should remain weak, but given recent statements by SK Hynix on pricing, these could be bottoming soon.

The $64k question is – is there a potential price war in the offing that could weigh on gross margins further? The high-end market is saturated......

4) Why has Apple’s management started to “blow the trumpet” on its Services business in the last three months? It is focusing on 10% of group revenues and probably 10-15% of group profits! Is it to show that Apple believes that it has a "recurring revenue" model? Is it to tell investors, that they are focusing too much on the iPhone which is ~60% of revs and 85% of operating profits? Is it to say to the Market, "hey, you are already valuing us at 10x earnings (inc cash), now, if we have the same multiple as Internet services companies on our Services business, then that multiple would be lower still? Or is it an admission that the best days of this fantastic company are now behind it?

Apple remains a value trap in my view, unless there is some magical transformation, a large lateral deal, a move into a new very large industry (the iCar anyone!). And even then, it’s difficult to compensate for the iPhone business that delivers $150b in annual revenues and $50b+ in operating profit. I rate Apple a Sell......

You May Also Be Interested In

• Midday movers: Novavax, Nvidia, Sweetgreen rise; Moderna, Yelp fall
• Plug Power (PLUG) PT Lowered to $3 at Canaccord Genuity
• Hippo Holdings Inc (HIPO) PT Raised to $22 at Keefe, Bruyette & Woods