Apple Inc. (NASDAQ: AAPL) has been a stock market darling for years, and many see this stock going nowhere but up. More often than not, analysts are caught chasing this stock higher, but one analyst is hedging his bets. This one analyst actually downgraded Apple.
Wamsi Mohan at BofA Securities downgraded Apple to a Neutral rating but increased the price target to $470 from $420.
In his report, Mohan argues for a valuation multiple rerating. Recently, Apple shares have experienced a rapid multiple expansion (five multiple turns), at the same time calendar 2021 estimates have largely been unchanged. So something has to give.
Another thing to consider, Mohan points out, is that the expansion in Apple’s valuation multiple has been quick and now Apple stock trades at the highest premium to the S&P 500 in 10 years. Raising the price objective makes sense, and at the same time the Neutral rating in this situation does as well.
Mohan’s report details:
We are concerned about the following risks to calendar 2021 estimates (1) Product gross margin (GM) pressure from higher BOM costs for the 5G iPhones, (2) Unit volume risk in case of higher ASP to compensate for GM pressure, (3) Tough compares in 2021 from an unsustainable trajectory (30% growth) of high margin App Store growth, (4) Pressure on services GM from content amortization costs, (5) Lower impact from share buybacks, and (6) potential risk of a higher tax rate in the event of a democratic win in the US elections in Nov. Covid-19 progression, Anti-trust regulation on App Store, and China trade risks create additional risk to the calendar 2021 $17 EPS buyside expectations. Services deceleration and lower GM create incremental risk to the multiple. Our new PO of $470 (was $420) is based on 28x (prior 25x, higher multiple on stronger services margins) calendar 2021 estimated EPS of $17.07.
The takeaway here is that BofA Securities is very sensitive to the risk profile associated with Apple. While there is still upside for the stock as reflected in the price objective, the risk/reward profile has evened out for the stock as it trades at a high premium relative to the market.
Mohan even notes that this call could be problematic if there is a stronger than anticipated cycle from 5G iPhones. Other risks to the upside include gross margin, fund managers closing the underweight gap, or even a weak dollar.
Mohan concluded the report with BofA Securities Investment Rationale:
We rate Apple Neutral as we see risk-reward balanced: Positives are (1) product cycle is less material, (2) Loyal user base, (3) installed base still growing, (4) services penetration remains low, and (5) strong FCF. Negatives are (1) valuation has moved to higher end, (2) there is potential for C21 to experience risk to margins and services growth, (3) the impact of buybacks is much more muted, (4) the growth in recent results is more from cyclical vs secular parts of the portfolio.
Apple stock traded at $439.95 on Wednesday, in a 52-week range of $193.82 to $446.55. The consensus price target is $415.90.
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