Apple's Growth Drivers: Television, China, & Pricing Power
Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Apple's (NASDAQ: AAPL) conservative valuation means that any meaningful growth in earnings in 2013 could drive the stock upwards. Though growth can come from many different areas, three potential growth drivers cannot be ignored when analyzing Apple's prospects: an Apple television set, growth in China, and continued pricing power.
An Assault on the Living Room
If Apple isn't doing market research for a potential Apple-branded television, they have no reason to fret; Wall Street is so intrigued by a potential iTV that they are conducting research on Apple's behalf. Morgan Stanley's Katy Huberty, for instance, surveyed 1,568 U.S. heads of households regarding an Apple-branded television set. Applying conservative reasoning to the survey responses, Apple could sell as many as 13 million iTVs in the U.S. alone. Furthermore, the respondents were willing to purchase an iTV at an average price point of $1,060, 20% more than they paid for their current TVs. Though 1,568 respondents is a small sample, the responses offer a compelling story.
Assuming Apple sells 20 million $1,060 iTV's across the globe with a gross profit margin of 13.5%, half of Apple's TTM net margin, an Apple-branded television set could add $2.85 billion to Apple's 2013 earnings. Then there's the improved, stronger ecosystem across Apple's products that would result from an Apple-branded living room. This, of course, makes Apple's products even stickier, increasing switching costs for consumers.
China: To the Tune of 700 Million
Apple's opportunity in China is enormous. The country has well over 1 billion wireless subscribers and a clear growth market in 3G adoption -- Apple's bread and butter.
Then there is China Mobile (NYSE: CHL), the world's largest carrier, that has yet to sell the iPhone. At 700 million subscribers, the opportunity for Apple is enormous. Yes, China Mobile's 3G subscribers amount to just 82.4 million, but 3G adoption is booming. In November, China's total 3G subscribers grew 88%, year-over-year, to 222 million. If this growth rate is halved in 2013, China 3G subscribers could increase by a whopping 98 million.
Clearly, Apple's fiscal 2012 gross profit margins of 44% point to significant pricing power -- no competitor even comes close. But Wall Street predicts margins to suffer in 2013. Given Apple's conservative valuation, the company doesn't need to increase margins to drive growth in its stock price -- it only needs to maintain them.
While Apple's FQ1 guidance for a gross profit margin of 36% was lower than the Street's expectations, the company noted in the FQ4 earnings call that the margin compression wasn't a result of any long-term changes in Apple's economics. Yes, the iPad Mini's gross margin is significantly below other products. But the iPad Mini represents a very small portion of Apple's net income. So why did Apple guide so low? Apple expects 80% of its revenue in FQ1 to come from new products -- a very unusual circumstance for the company. Furthermore, Apple's CFO noted that they don't see anything "structurally different this time around" regarding Apple's cost curve and the company's ability to reduce costs as production increases.
Priced for Mediocrity
Using a reverse valuation based on free cash flow (FCF) trends and a 12% discount rate, it is possible to find the growth rate the market is assuming in order for Apple to be fairly valued at today's price. Apple's growth rate assumed by the market is just 11%, very low considering its year-over-year growth in FCF amounted to 38%.
In contrast, Google's (NASDAQ: GOOG) growth rate assumed by the market is 17.2%, despite a year-over-year increase in FCF of just 13.9%.
Taking analysts earnings estimates into consideration, forward P/E ratios tell a similar story: Apple's forward P/E ratio is just 8.8 while Google's is 14.9.
The Bottom Line
If Apple delivers on any one of these growth drivers in 2013 there is room for upside. Even better, if Apple delivers on a combination of these growth drivers in 2013, investors could be in for another great year of market-crushing returns.
DanielSparks owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, China Mobile, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!