Technology

Why Merrill Lynch Downgraded Apple

Apple Inc. (NASDAQ: AAPL) may be the darling of Wall Street and Main Street alike. It is the most profitable and the highest market cap company of all companies in the world. And its chart entered into a trouble zone this week. Now we have one fundamental change from Wall Street, with Bank of America Merrill Lynch downgrading Apple.

The firm’s formal Apple downgrade went from Buy to Neutral, and the formal price objective went to $130 from $142 in the call. Merrill Lynch’s Wamsi Mohan worries about a deceleration in iPhones creating near-term headwinds for Apple. Mohan still sees the long-term opportunity being significant.

The driving forces for the downgrade and headwinds are a significant slowdown in revenue growth, China accounting for about 25% of iPhone sales, the stock price being correlated to gross profit dollar growth, Apple’s beats are diminishing and creating higher risk to negative revisions, and not seeing incremental capital return announcements beyond the already announced plans in the near term.

The firm does address new products and initiatives. The smartwatch, Apple Pay and music are seen as long-term great drivers but slow in the near term. These were seen adding to earnings per share as follows:

  • A $0.30 EPS impact from Apple Watch in 2016
  • An $0.11 impact from Apple Pay
  • The contribution from music will remain less than $0.10 per share in 2016

Merrill Lynch is not really bashing Apple in the call. In some ways it almost apologetic about the downgrade, and its earnings estimates used are actually above the Thomson Reuters consensus. Wamsi Mohan said:

We do not dispute that valuation metrics remain compelling for Apple; however, in the last down-cycle despite compelling valuation the stock retraced 30%. Apple’s stock has rallied 40% in 2014 and is trading at multiples at a slight discount to peers.

The firm even noted that there are ways it could be wrong in this downgrade. Further iPhone market share growth over Android would lead it to be wrong, as would increased enterprise penetration or a reacceleration in iPads.

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Merrill Lynch’s new price objective of $130 is based on a low multiple of 13 times its expected $9.99 in earnings per share in 2016. Apple’s consensus price target from analysts as a whole is $147.29, and it has a consensus from Thomson Reuters of $9.78 in earnings per share in 2016.

Also included here is the post-earnings analysis for Apple.

Apple shares were down 1% at $113.50 or so in premarket trading on Wednesday. That might have been worse had S&P 500 futures not been up 15 points and Dow futures not been up almost 100 points.

 

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