Apple: A Contrarian Investor's Dream Stock?

It has been a turbulent time for Apple investors as the share price fell from highs of $705 last year to close at $390 on Friday.  With their Q2 results to be released on Tuesday, it may be a brave call to jump in before, however for the contrarian investor is this the perfect opportunity?

Why has the share price fallen?

The stock has fallen 45% since its high in less than twelve months on fears that their flagship products; the iPhone and iPad are losing market share demand of the ever more competitive market.   

A number of companies who supply Apple parts have announced slowing sales which have spooked investors.  Cirrus Logic (CRUS) which supplies analogue and audio chips for the iPhone and iPad announced good earnings, however ended the year with over $20m in inventory reserves which suggests slowing demand for Apple’s products.  

The last five years have seen Apple in its mass growth phase, and it is difficult to quantify earnings potential and product demand until market saturation has been met.   The latest announcement from Cirrus Logic highlights just this, whilst they had a great year, they may have overestimated continued demand for Apple products.

The IDC recently released data for their Quarterly PC Tracker and revealed preliminary estimates had Apple ship 1.4m units, a 7.5% decline since 2012.  They noted that this decline may have been due to a steep rise in competition for the iPad.  With more competitors producing cheaper products, market share has been eroded.

Will Earnings Suffer?

Whilst Apple has been relatively reserved about pipeline products their current ones do a great job in hooking people for their next models.  In 2011, UBS carried out some research into retention rates for the iPhone; this was a whopping 89% with its nearest competitor at 39%.  Whilst we are a couple of years down the line, previous earnings have supported the results.  The 2013 Q1 results showed a record haul for iPhone sales of 47.8m units compared to 37m a year before, iPads also followed suit selling 22.9m compared to 15.4m the year earlier.

Although Apple looks to have more competition against Samsung and Microsoft the projected earnings for this year don’t look to suffer that much as a result.

First quarter in 2013 saw record revenue at $54bn, however gross margin had decreased somewhat from the year before.

The fall in the share price has been attributable to very little hard facts and mostly on speculation. Whilst many have been worried over the reducing gross margin, this may have be down to cyclical factors used in product development.  With the earnings looking to remain solid for 2013, contrarian investors will be licking their lips as the stock remains out of favour falling below $400 a share. 

Earnings per share looks to remain flat for 2013 which will not come as a surprise to many because the gross margin looks to decrease somewhat from 2012.  Capital equipment expenditure ahead of the iPhone 5 release may have been the cause for this gross margin decrease and has the potential to rise again once the iPhone 5S is released as modifications to hardware are likely to be minimal. 

Using Apple’s lower end estimates they are looking to grow revenue and net profit for 2013.  The current share price, just based on earnings is very low and factoring in the vast amount of cash on their balance sheet, $150bn, the company looks even more attractive.   Looking at Google Inc (GOOG) a company with similar merit, they have a P/E of 24.3 compared to Apple’s 8.7 (without $150bn cash)!

What is next for Apple?

Pipeline products are fundamental in this fast paced technology sector, and the company has been relatively quiet about what is to come.  They have hinted at a cheaper iPhone which should help snatch up some of the market share against the cheaper competitors and a new iPad release.   It is likely there are more products on the development line which are sure to draw in a huge amount of revenue, however it is hard to pin point release dates.

China Mobile is one of the world’s largest mobile networks without direct access to the iPhone and this may be about to change as they look to invest $30bn in the new 4G network that will support it.  Much time has been spent in generating a relationship with the company and this summer may see Apple gain further exposure to the Chinese market.

One thing is certain, the ever growing cash level that dwarfs Apple’s competitors provides potential for some significant developments.  There are a number of uses for this cash that will be beneficial to the share price such as research and development, M&A, share buy backs or increased dividends. 

The share price has fallen back to levels seen towards the end of 2011 and it is unlikely earnings are going to do the same.  The market is pricing in a dramatic fall in earnings for 2013 and subsequent years (almost 50%) and do not take into account new product releases. 

Out of 55 broker recommendations, 80% rate this stock as a buy with a mean price estimate of $602.  

Apple is a prime example of what contrarian investor’s look for; stocks that are out of favour with earnings and balance sheet strength.   I agree with the brokers and at $390 Apple shares are a steal.