What's Apple Worth As A Fashion Stock?
Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The mayhem surrounding Apple (NASDAQ: AAPL) continues. Recent news that investor David Einhorn is battling the company over its enormous cash hoard certainly gained a lot of headlines. A piece having money manager Bill Miller opine that the stock could rise 50% and another article that conversely suggested it could drop to near $300 also caused investor excitement.
Yet even with all the noise, one rarely hears a compelling argument related to the company's intrinsic business value. This might not be as surprising as it seems. I believe that Apple has been transformed over the last 5 years into more of a fashion-related company than tech company. Since the majority of analysts following the stock specialize in technology it seems logical that they wouldn't feel comfortable making an appraisal on a fashion industry basis.
Is Apple a fashion stock? Here are a few reasons why I think so:
1. As the competition has closed the technology gap, product differentiation is increasingly based on design. As in fashion, Apple seems increasingly concerned about attributes such as color, size and fit.
2. A major selling point of Apple products is a "cool factor." Since the Macintosh in the 1980’s, to the iPad introduction in 2010, Apple products were viewed as something special. The epitome of Apple "cool" has been demonstrated with the iPhone craze. Not only did the company build its product into a must-have, a judge in the U.K. patent case even wrote in his decision that Samsung's product was "not as cool" as Apple’s.
3. The company's business model relies on selling this "season's" offering. Like fashion's big season kick-off, Apple seems to rely on an annual new product introduction to drive sales. I don't think it's a coincidence that these introductions are aimed at getting previous buyers to put last season's purchase in the closet and pick up the latest version.
Given this thesis, it wasn't shocking to see Apple's increased presence on the fashion conscious TV home shopping networks.
So what if Apple is a fashion company. The key question remains "What's it worth?"
To get a good estimate of Apple's fair business value it helps to get a comparison to its peers. I used a couple of high-premium, well-known fashion brands for my analysis. Ralph Lauren (NYSE: RL), a leading designer of apparel and Tiffany & Co. (NYSE: TIF), the famous operator of jewelry stores and producer of personal ornaments.
Assuming Ralph Lauren has annual sales around $7.8 billion and average adjusted cash earnings of $882 million, its reasonable business value would be around $155 to $174 per share based on a multiplier between 16x and 18x. This seems pretty close to the company's 52-week range of $134 to $182.
For Tiffany, with estimated sales of $4.1 billion and an average adjusted cash earnings level of $548 million and using a multiplier of 16x to 18x, the company’s fair value equates to between $69 and $78 a share. Again resembling its 52-week range of $50 to $74.
When it comes to Apple, I'm assuming base case annual sales around $175 billion (a 12% increase to fiscal 2012) and average adjusted cash earnings of $38 billion (assuming a 35% pretax margin).
But some necessary adjustments have to be made to the base case.
Apple is highly dependent on carrier subsidies for its main iPhone product. I think the strong likelihood of these subsidies being decreased has to be factored in. (For more on Apple's subsidy risk, see this post.) An estimated cut in subsidies by 33% would reduce revenues and cash earnings by about $16 billion.
On the other hand, Apple should be given the benefit of its huge amount of cash. I don't think it makes sense to give its cash pile value on a dollar-for-dollar basis but it could be used to reduce the number of shares outstanding. The use of $30 billion, or about 75% of their liquid cash, for a buyback at $450 a share reduces the share count by 67 million to roughly 880 million.
So, the adjusted Apple valuation estimate assumes yearly sales at $159 billion with average cash earnings of $29 billion. Using its peer multiplier spread of between 16x and 18x, a reasonable fair value range looks to be around $527 to $593 per share.
But there should be some caution on the precision of the estimate. This valuation is contingent on maintaining a 35% pre-tax margin and that may not be likely. A seemingly small deterioration in the margin can have a meaningful effect on value. For instance, a pre-tax margin slip to 33% would cut about $35 off of business worth.
The appraisal also assumes Apple will use its cash intelligently. For example, simply using $30 billion to buy back stock at $550 per share rather than $450 would knock around $10 off the estimate.
Finally, as a fashion company, Apple is increasingly at the mercy of consumer taste. If Apple products go out of vogue for any reason, these fair value assumptions would probably be highly exaggerated.
Obviously, a lot more investigation is necessary to get a better evaluation of Apple's worth. But given all the noise surrounding the company and the increased volatility in the stock, this exercise might be a helpful benchmark for further study.
grahamsway (Bob Chandler) has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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!