February 3, 2016

No point owning Apple shares right now

Stated simply, Apple's quarterly results and message behind it were "Crapple."

    "Stay hungry. Stay foolish."     -- Late Apple co-founder and CEO Steve Jobs

Steve Jobs famously gave a moving commencement address at Stanford University's 2005 graduation ceremony where he uttered the above four words and made them famous.

But I believe it's now foolish to own Apple shares. If I owned the stock, I would sell it -- as my analysis continues to suggest that the company's best days are behind it. I think AAPL's future sales-and-profit outlook is worse than consensus expectations, and that the tech giant's valuation faces numerous headwinds.

Despite bullish protestations from the sell side and numerous large Apple stockholders (e.g., Carl Icahn), my negative view has been firm and consistent over the past year.

I now expect Apple to produce three consecutive quarterly earnings-per-shares results over the balance of the company's fiscal year that are down on a year-over-year basis.

And I project lower and below-consensus results for the full fiscal year as well, down 7% to 10% to around $8.50 a share vs. $9.20 a year earlier. Furthermore, I don't expect fiscal 2017 EPS to meet FY 2015's results.

This means that in order for Apple's shares to rise over the next two years, its price-to-earnings ratio must rise even higher -- something that I don't expect for many reasons. Personally, I'm maintaining my short position on AAPL and keeping the stock on my "Best Short Ideas" list.

I updated my bear case for Apple a few weeks ago. My constant refrain has been that Apple's greatest threat is its past successes, which have ballooned the company's size whether measured by sales, profits or market capitalization.

That means gains from current market value or operating successes have grown more difficult to achieve in the face of the difficulty in providing new products that can meaningfully impact Apple at the margin. This challenge was omnipresent throughout yesterday's earnings release and conference call.

In some ways, the challenges facing a maturing Apple and the headwinds to the company's stock outlook are more difficult and fundamental than those that existed at the stock's September 2012 share-price peak. 

In typical herd fashion, analysts have almost universally responded to yesterday's results by stating that AAPL is "cheap." They argue that investors should buy on the bad news because of Apple's expanding ecosystem, large cash-flow generation and sizable cash balances.

But increasingly, the sell-side community seems to me to be defending the indefensible. I demur on all counts:

"The stock is cheap" argument claims AAPL is a bargain because yesterday's results were better than feared, but that's just Wall Street humor. If Apple is really cheap, then why did most analysts take a hatchet to their numbers?

By the way, FBR and Barclay's used almost the same "not as bad as feared" words in their analyses.

Don't Blame China

In a departure from the prior quarter, Apple CEO Tim Cook blamed the global economy for some of the company's woes. We're conscious that China is slowing, but Cook should stop with the excuses about the economy, as both analysts and management have asserted that Apple has never been about the economy.

And if Apple is now linked to economy (given that the iPhone's last product-cycle upgrade is nearly finished), then we must recognize that Apple is a maturing industrial company. In that case, management and shareholders shouldn't be surprised by AAPL's current P/E of around 11.

The reality is and has been that the company's "story" has mostly been about Apple's product cycle. The fact is that Apple was absent from the big-screen market for two years and has backfilled an enormous amount of latent demand. This was a "game changer" that took the company's selling trajectory above its natural run rate, but borrowed from the future in the process. 

Apple also went hard into China at the same time, but now the company's new-product cycle is almost over. On top of that, they stuffed a bunch of product into the channel, making the eventual downside worse.

Tim Cook and John Chambers

Tim Cook is starting to remind me of John Chambers, CEO of Cisco (CSCO). Chambers also started to whine more and more about the economy when CSCO was no longer a growth business in the last cycle. (He never talked about the economy when things were good and the Cisco enjoyed the tailwinds of a strong and dominant product cycle).

Large Cash holdings

The "Apple has a large cash hoard" argument falls short on several fronts to me.

First, as I wrote previously, AAPL's net-cash levels are flat-lining. As I noted: "Several commentators have mentioned recently that Apple has over $200 billion of cash. While that's factually correct, we should look at cash net of debt -- which in Apple's case has been flat-lining for a long time (principally due to share buybacks)."

And more importantly, every dollar of Apple's cash that's overseas has nowhere near $1 of worth to shareholders, as it faces U.S. taxes if it's repatriated to America.

The Bottom Line

    "Our goal is to make the best devices in the world, not to be the biggest."
    -- Steve Jobs

The business media initially reported Apple's earnings yesterday as a "beat," although all of the analyst estimates had gotten cut big time. And Apple missed the lowered estimates in all product categories.

So, the bottom line for me is simple: Sell Apple. Peak Apple. It's ... Crapple.

Position: Short AAPL (small)