Apple Reduced to 1% Client Position (down from 5%) With No Regrets

A lot of times in the investment business, advisors will take a position (either a purchase or sale, or economic forecast or market call) and then work to justify the forecast, despite everything about the forecast looking wrong.

There is a thin line between principle and stupidity.

Clients had their Apple position reduced substantially in Q1 ’18, from a 5% position to a 1% position, with the stock sold in two pieces, near $168 and then again at $161.

To be blunt, given the $182 print today, the sale doesnt look so smart. yet, I’m still glad it was done for clients.

is a bad sale being further rationalized ? Possibly.

However, here is rationale for the reduction in Apple’s position:

1.) iPhone cycles are becoming progressively less powerful:

Starting in 2013, when Apple’s stock fell 50%, after the launch of Apple iPhone 4 & 5, (2013 saw the various iterations, such as 4S, 5S, etc.) and the stock started to trade like a growth cyclical, each iPhone cycle has seen a progressively lower revenue ramp:

  • 2018 (est) +15%
  • 2015: +28%
  • 2012: +44%

Granted, for a company Apple’s size, 15% revenue growth isn’t too shabby. But the fact is, all we heard about was the “Super Cycle” for the last year, and as one analyst commented, the cycle isn’t so super (so far).

iPhone unit growth was just 3% in the March ’18 quarter, and the iPhone unit growth hasnt surpassed single-digit growth since the September, 2015 quarter, when 22% unit growth was seen.

2.) Here is what is a little more worrisome:

As a test of “quality of earnings” here is the trend in Apple’s “4-qtr trailing cash-flow vs 4-qtr trailing net income”

  • Mar 18: 126%
  • Dec 17: 128%
  • Sep 17: 132%
  • Jun 17: 137%
  • Mar 17: 132%
  • Dec 16 145%
  • Sep 16: 144%
  • Jun 16: 132%
  • Mar 16: 145%
  • Dec 15: 140%
  • Sep ’15: 152%
  • Jun ’15: 160%

Is this a meaningful metric ? Personally I’m more interested in the trend than the overall coverage.

To take this one step further, and to compare free-cash-flow to net income, FCF is still just a little bit more than 1(x) net income, but that is down from 137% since June ’15.

Maybe its the conversion from a electronic device or consumer electronics company to a “services” company.

Conclusion: If this blog post ever hits the light of day, particularly if Seeking Alpha picks it up, no doubt i will be lit up like a Christmas tree, but the fact is the iPhone cycle is getting “less robust” and the cash flow relative to net income is showing a less robust cash-flow and free-cash-flow generation.

The thing that is astounding about Mr. Buffett, who is the greatest investor of the last 60 years, is that he bought Apple after a monstrous 18 year bull-market run.

Look at what happened to what I call Tech’s “Original Gangsters” of the 1990’s (MSFT, INTC, CSCO, etc) : once their growth slowed or stopped and the Tech cycle rotated from a secular corporate build-out of Tech in the 1980 and 1990’s (PC’s, server’s, etc.) to consumer Tech like Apple, Adobe, etc. it took 10 – 15 years for those companies to re-engineer and await the next Tech wave. (Long all for clients in small pieces, except Microsoft which has been client’s largest position the last 5 calendar years.)

Tim Cook is probably highly under-rated as a CEO: if he can grow the Services business to succeed or supplant the inevitable slowing and death of the iPhone. he will be one “rad dude” to use the Valley slang. I just dont think its going to be that painless, i.e. the business model transition that is.

Remember, the iPhone is counting on “price increases” which throws the traditional technology pricing curve on its head. the iPhone is still 60% – 70% of Apple’s total revenue each quarter.

To caution readers this is a very contrarian opinion about one of the most popular tech stocks of my generation.

The above opinion could be very wrong and for a while too.




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