Morgan Stanley's Huberty Dismisses Concerns Over Apple's (AAPL) 2022 Growth Prospects, Bumps PT; Says iPhone 'S' Cycle Is Different This Time and Sees 'Good' LT Buying Opportunity

June 24, 2021 8:57 AM EDT
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Morgan Stanley analyst Katy Huberty has noted investors’ concerns over Apple’s (NASDAQ: AAPL) growth outlook for FY22 amid the expectations for an iPhone S-cycle and diminishing cyclical work-from-home (WFH) trends.

While the analyst “recognizes these risks,” Huberty is more positive on the long-term outlook for AAPL. For her, these concerns have actually created a good long-term buying opportunity as shares trade at 24x EV/FCF.

“Incoming call volume on Apple is as low as we can remember over the last 5 years, which we believe stems from 4 main factors. First, we are at a seasonally low period in the iPhone cycle, which creates a demand information vacuum and elevates the relative impact of supply chain noise. Second, Apple is increasingly in the eyes of regulators,and while we believe their model is defensible (read more here), regulatory risk is likely to remain a stock overhang (we'd argue it is for Apple's comps as well, reflected in peer multiples). Third, as the world slowly returns to normal, there are concerns that cyclical work and learn from home demand will decelerate at the same time Apple faces increasingly difficult comps. And fourth, investors fear that a more evolutionary (rather than revolutionary) iPhone s-cycle will lead to extending iPhone replacement cycles and Y/Y revenue declines next year, increasing the likelihood of negative estimate revisions in FY22,” Huberty said in a note on AAPL.

One of the reasons why Huberty is bullish on AAPL is her expectations that the June quarter will be better-than-expected, driven by strong iPhone and iPad demand. Hence, the analyst increased sales and EPS estimates by 3-5%, as well as a price target to $162.00 per share from $161.00 on the long-term opportunity.

“However, we also recognize that the Apple bear case of double-digit revenue declines and EPS pressure in FY22 will not be disproven in the June quarter, making Apple's catalyst path more back-end loaded this year. Nevertheless, we believe that Apple can drive low-teens annual revenue growth and high-teens annual EPS growth between FY20 and FY23, which supports our 31x EV/FCF target multiple.”

Some Apple bears outlined a case that the company’s iPhone is entering a more modest upgrade, or "s" cycle. This is when iPhone sales historically plunged at a double-digit rate. Huberty doesn’t agree with them and outlines four key factors that support her bullish case.

“We view this as a poor comparison to the upcoming cycle and see low risk of similar iPhone revenue declines next year for a number of reasons. First, during past "s" cycles iPhone replacement cycles extended by ~0.8 years which is an unreasonable scenario given the starting point of 3.7 years today, which is already well ahead of notebook replacement cycles. Second, Apple recently expanded trade-in, financing, and installment offers which improve iPhone affordability relative to past "s" cycles when like for like prices increased. With the help of these programs, many existing iPhone users are opting to purchase more expensive devices which is lifting ASPs and margins, a trend that feels sustainable given the strength of consumer balance sheets heading into FY22. Third, 5G adoption is still in the early stages, at 9% installed base penetration globally and 11-21% across Apple's two largest markets (the US and China).”

Finally, Huberty argues, iPhone sales were hit by store closures in the first half of the last year, which won’t repeat again.

“While supply chain data points don't provide much visibility beyond the near-term, initial chip orders for the A14 chip to be introduced in September 2021 are 100M units in C2H21, up from 95M units in C2H20, a constructive indicator that iPhone sales could hold up better than feared. Taken together, these factors build confidence that the iPhone 13 cycle will not look like past s-cycles, which is reflected in our updated FY22 iPhone forecast of 231M units (+1% Y/Y and vs. consensus of 236M), up from 228.5M previously. We'd note that investor feedback suggests buy-side FY22 iPhone expectations are well below current sell-side consensus with many investors fearing a double-digit iPhone revenue decline like in FY16 (iPhone 6s) and FY19 (iPhone XS),” the analyst adds.

Moreover, Huberty stresses that Mac and Services growth looks more secular than cyclical.

“Growth in products such as iPad and Mac, and digital services like the App Store accelerated during COVID but in some cases this growth is more secular in nature. For the Mac, Apple has its most competitive product line ever to compete in what we believe is a structurally larger PC market, and we expect Apple to launch new, larger-display MacBook Pro's with 2nd generation in-house designed silicon later this year, further broadening the reach of Apple's M1 chipsets and helping to sustain growth and market share gain.”

Finally, Apple’s current market price of $$133.98 presents a good long-term entry opportunity.

“In our view, the disconnect between our SoTP-driven price target / platform peers valuations and Apple's current 24x EV/FCF valuation presents an opportunity for long-term investors to purchase a high quality consumer technology asset at a meaningful discount to peers. And we believe that as the market better appreciates the durability of Apple's growth over the next 12 months, Apple shares will undergo a multiple re-rating towards our $162 price target, similar to how Apple's P/E expanded 7 turns during the last iPhone "s" cycle as fundamentals proved to be more sustainable than expected, despite iPhone revenue pressure,” Huberty concludes.

Apple stock price is up 0.7% in pre-open Thursday.

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