Apple has a lot to prove, this investor says

US tech giant Apple (Apple Stock Quote, Charts, News, Analysts, Financials NASDAQ:AAPL) has been a hot stock of late, rising about 24 per cent since the start of June. That’s good for Apple shareholders but it might make it a little tougher on the company to justify it valuation, according to portfolio manager Kim Bolton, who thinks the company needs to show that it’s more than just a smartphone business.

“Next week is the big launch for their iPhone 13, next Tuesday, so here we are sitting at around $154-$155. We have a 12 month price target of $164, so there’s a bit of a runway in front of it,” says Bolton, president of Black Swan Dexteritas, speaking on BNN Bloomberg on Thursday.  

“I think [investors] might actually find over the fall here some opportunity to actually add to their positions,” he said. “Apple is facing some potential headwinds regarding its Apple Store take rate, but these issues in the Apple Store are nothing new for the company.”

“And even though the iPhone is still the key revenue and profit driver, you have to watch how they’re doing on their fast-growing Services segment. Apple needs to demonstrate that it can grow this segment quickly moving forward to justify its premium valuation — and it is rich,” Bolton said.

The annual September launch of the new iPhone is upon us, with this year’s edition expected to include a number of iterations — the iPhone 13 Pro, the iPhone 13 Max and the iPhone 13 Mini — all aimed to entice Apple fans to ditch their rusty old contraptions for something new and shiny. Camera upgrades are assumed as are larger-life batteries, while Apple may also be splashing out new versions of its other hardware like the MacBook, iPad and Apple Watch.

And while the company’s dependence on iPhone sales — revenue from iPhones made up a full 48 per cent of total sales for its most recent quarter — has been a knock on Apple for years now, the concern seemingly won’t go away, even with its Services business picking up steam. 

Services, which include items like Apple TV, Apple Music, AppleCare and iCloud storage subscriptions, saw revenue grow by a very healthy 33 per cent in the company’s fiscal third quarter 2021 for the period ended June 30. The Q3 breakdown saw iPhone sales at $39.6 billion compared to Services sales, which represented the next-largest segment, at $17.5 billion. (All figures in US dollars.)

“Our record June quarter operating performance included new revenue records in each of our geographic segments, double-digit growth in each of our product categories, and a new all-time high for our installed base of active devices,” said Luca Maestri, Apple’s CFO, in the third quarter press release.

“We generated $21 billion of operating cash flow, returned nearly $29 billion to our shareholders during the quarter, and continued to make significant investments across our business to support our long-term growth plans,” he said. 

But Bolton sees trouble in the numbers, pointing to Apple’s PEG ratio as an example.

“When you look at the growth and you look at the earnings power, having a forward price-to-earnings ratio of almost 28x isn’t that concerning. However, the surging PEG ratio is a bit of a concern for us,” Bolton said.

“The PEG ratio is the valuation measurement that compares the company’s price/earnings ratio to its expected earnings growth rate, and Apple’s forward PEG ratio has absolutely surged this year, up to 5.51. So that is a bit of a concern for us,” he said.

“So, we watch it very carefully. I haven’t written any calls against Apple yet, but it’s certainly on our on our minds. Given the valuation right now, it’s hard to justify a Buy rating right here, but we don’t discourage anyone from betting against this company, either,” Bolton said.

Morgan Stanley analyst Katy Huberty lifted her target on Apple ahead of the company’s third quarter results, saying Apple’s product release cycle in 2022 will be a boost for the company. 

“We are buyers heading into the iPhone 13 launch in September,” wrote Huberty, as reported by Apple Insider on July 15. “We see the combination of mature replacement cycles, increasing 5G adoption, improving retail store traffic, longer battery life and camera quality, and share gains against Huawei as drivers of iPhone outperformance relative to past s-cycles.”

Huberty took her target from $162 to $166 per share, which at press time represented a projected one-year return of 14 per cent.

Last month, Goldman Sachs analyst Rod Hall said revenue growth for Apple looks to be slowing down after a boost over the COVID-19 pandemic where tech sales boomed.

“Their user base growth has been slowing by Apple’s own metrics,” said Hall in a CNBC segment on August 25. “You see about a five per cent annual growth rate in that user base and we think that growth is slowing … the Revenue Per User (RPU) looks like it will probably reverse and then remain roughly stable in years after this.”