{"id":90786,"date":"2024-05-05T00:00:45","date_gmt":"2024-05-05T04:00:45","guid":{"rendered":"https:\/\/ifintechworld.com\/?p=90786"},"modified":"2024-05-05T00:00:49","modified_gmt":"2024-05-05T04:00:49","slug":"apples-buyback-news-may-be-late-for-warren-buffet-theres-still-some-risk-aapl","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=90786","title":{"rendered":"Apple’s Buyback News May Be Late For Warren Buffet – There’s Still Some Risk. (AAPL)"},"content":{"rendered":"
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Investment Thesis<\/h2>\n

Apple (NASDAQ:NASDAQ:AAPL<\/span>) recently announced its Q2 FY24 earnings results that beat estimates. Two straight takeaways from their earnings report were the hardware devices business not doing as badly as markets estimated and its record share buyback program, which is now on record as the largest ever share repurchase program.<\/span><\/p>\n

This earnings announcement by Apple almost coincides with Berkshire Hathway\u2019s (NYSE:BRK.B) own Q1 FY24 earnings results, which showed the holding company had trimmed some of its Apple position.<\/p>\n

I believe this may be a smart move in the short term since I see some potential headwinds lurking on the horizon for Apple. I believe Apple\u2019s share buyback announcement was a tactically astute lever pulled by management in the light of falling hardware sales and a slow innovation pipeline.<\/p>\n

There is no doubt that over the long term, the company will demonstrate the resolve and promise to right the growth trajectory of its falling hardware sales and ramp up its innovation pipeline to better align with its long-term growth vision. Apple\u2019s services segment may step in to keep Apple\u2019s growth buoyant for the time being.<\/span><\/p>\n

But, for now, I recommend a Hold rating.<\/p>\n

Warren Buffet\u2019s commentary on Berkshire\u2019s Apple\u2019s shares<\/h2>\n

I expect Apple\u2019s shares to face immediate volatility given the news announcement of Berkshire trimming some of its Apple position, so I believe a summary of Buffet\u2019s views would be warranted before I proceed.<\/p>\n

From Saturday\u2019s earnings results announcement, I note that Buffett’s Berkshire Hathway stake in Apple dropped 22%, from $174.3 billion at the end of 2023 to $135.4 billion as of March 31 this year, despite Apple\u2019s stock falling ~11% between January and March of this year. Without Berkshire Hathway\u2019s 13-F filing ((to be filed on May 14), it will be difficult to provide exact numbers of how many shares were sold, but market estimates currently expect Berkshire to have cut its Apple investment by about 13%. When probed further on the exact reasons why Berkshire Hathway sold Apple shares, Buffet only said \u201ctax reasons.\u201d<\/em><\/p>\n

I expect this to create some volatility for Apple in the short term, but I also find it notable that Berkshire Hathway chose to reduce its stake in Apple now. Buffet has always been an advocate of companies buying back their shares to return shareholder capital. In 2018, when Apple announced their largest share buyback program at the time, Buffet said, \u201cWhen I buy Apple, I know that Apple is going to repurchase a lot of shares.\u201d<\/em> In his 2020 Annual Letter, Buffet also said:<\/p>\n

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The math of repurchases grinds away slowly, but can be powerful over time. The process offers a simple way for investors to own an ever-expanding portion of exceptional businesses.<\/em><\/p>\n<\/blockquote>\n

Yet, on the cusp of Apple\u2019s new record share buyback program, Buffet appeared to liquidate his stake in Apple.<\/p>\n

I believe Apple’s buyback program, while very much needed, is still not enough given its previous rates of share repurchase, which I will expand upon in the next section.<\/p>\n

Apple\u2019s buyback is great news but there are some subtle concerns<\/h2>\n

The big news to trickle out of Apple\u2019s Q2 earnings report was its massive share buyback program. This is by far the largest share-repurchase program the company\u2019s management has ever announced. I have added a chart below based on data compiled by Birinyi Associates going back to 1999 that illustrates the scale and magnitude of Apple\u2019s most recent share buyback announcement, which beat its own previous record for the largest buyback program ever announced in 2018.<\/p>\n

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\"Apple\u2019s<\/span>
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Apple\u2019s May 2024 share buyback program vs previous programs (Birinyi Associates via Bloomberg)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

Based on its recent quarterly filing, management still has about $30 billion in its war chest as part of all its previous buyback authorizations to repurchase shares from the market. Therefore, in total, I estimate Apple now has around $140 billion worth of funds to buyback shares. That equals ~5% of Apple\u2019s shares outstanding at the close of business on Friday last week. So, how does the company execute on the buyback program?<\/p>\n

Over the last ten years, management has bought back shares at a compounded growth rate of ~5.2%. However, management bought back shares at a quicker pace before the pandemic than after the pandemic, as seen in my annotations in the chart below.<\/p>\n

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\"Apple\u2019s<\/span>
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Apple\u2019s management has executed more buyback volumes before the pandemic than after (yCharts)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

As seen above, management has executed share repurchases at a compounded growth rate of ~3.8%, far lower than their pre-pandemic buyback repurchase compounded rates of ~6.6%. I believe part of the reason why Apple\u2019s management is constrained is due to its debt load and net-cash positions that conflict with its share buyback programs.<\/p>\n

To illustrate some of the constraints that Apple\u2019s management has, I have compared the interest coverage ratio of Apple versus Microsoft (NASDAQ:MSFT). The reason I have chosen Microsoft despite Microsoft being in slightly different businesses is because these two of the highest quality technology companies in the world compete for capital allocation, and I believe these two companies will constantly be compared against one another on a relative basis.<\/p>\n

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\"Apple\u2019s<\/span>
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Apple\u2019s interest coverage ratio is much higher than its peer (Company annual reports)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

From the chart above, I note that Apple spends a relatively higher amount on servicing its debt versus its peer, Microsoft (MSFT), which can be seen in Apple\u2019s interest coverage ratios. Interest coverage is essentially the amount of earnings before interest and taxes (EBIT) that Apple spends on interest expenses such as debt servicing. Since 2019, Apple\u2019s interest expenses have grown 2.4% CAGR, while Microsoft\u2019s interest expenses have declined by ~7% on average. Also, on a y\/y basis, I note that Apple\u2019s interest expenses have grown by 34% in its 2023 filing versus the previous year.<\/p>\n

At the same time, I also see that Apple\u2019s cash position has been declining over the years, as seen in the chart below. Per their latest second quarter figures, Apple\u2019s cash & equivalents position is now at ~$32.7 billion, up 9% from the ~$30 billion reported in 2023, as seen above, while their Q2 books currently carry ~$91.8 billion, a -3.6% decline from their 2023 numbers posted above.<\/p>\n

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\"Apple\u2019s<\/span>
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Apple\u2019s net cash position (Company sources)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

I believe since the company laid out its net-cash neutral goals in 2018, its management has prioritized re-distributing cash via share buybacks and dividends to its shareholders, but the rate of those repurchases has reduced. I believe a huge priority for Apple would be to balance its net cash and debt positions to cancel out one another, which is appropriate in the elevated interest rate environment it operates in today. In fact, when asked about its net-cash goals vs. whether management was ready to take on leverage in the future to expand its share buyback programs, here is what Apple\u2019s CFO had to say:<\/p>\n

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I would say one step at a time, we have put out this target of getting to net cash-neutral several years ago and we’re working very hard to get there. Our free cash flow generation has been very strong over the years, particularly in the last few years. And so as you’ve seen this year, we’ve increased the amount that we’re allocating to the buyback. For the last couple of years, we were doing $90 billion, now we’re doing $110 billion. So let’s get there first. It’s going to take a while still. And then when we are there, we’re going to reassess and see what is the optimal capital structure for the company at that point in time.<\/em><\/p>\n<\/blockquote>\n

I believe that without any significant improvement in Apple\u2019s net cash position, the company will be constrained by carrying a heavy debt load on its books, putting it in a less favorable position to execute on their massive $110 billion buyback program. I’m quite sure management is aware of this, and I expect them to err on the side of caution when executing their share buyback authorizations.<\/p>\n

Simultaneously, Apple will also be looking to infuse growth back into the sales of its hardware devices, which have been decelerating for a while. As seen in the chart below, in every device category, barring Mac products, sales declined versus last year. The biggest decline was seen in its iPhones, which declined over 10% versus the previous year\u2019s Q2.<\/p>\n

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\"Apple\u2019s<\/span>
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Apple\u2019s devices revenue declined considerably versus last year (Company sources via Statista)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

Management has been adamant about its AI projects and how it eventually ties its AI ambitions into its iPhone. So far, the only tangible AI feature is unofficial news pointing to some sort of embedding of Google\u2019s Gemini into the iPhone. Apart from that, management has continued to do the most Apple-esque thing it can do by being secretive about its AI projects. The most management said on the Q2 earnings call was to expect some more announcements in the future:<\/p>\n

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I think AI, Generative AI and AI, both are big opportunities for us across our products. And we’ll talk more about it in the coming weeks. I think there are numerous ways there that are great for us. And we think that we’re well-positioned.<\/em><\/p>\n<\/blockquote>\n

Therefore, until investors get a clear direction of product strategy from management in today\u2019s backdrop of AI, there will be some overhang on the stock\u2019s price. Then, there are also the added headwinds from China that are casting a shadow over the company\u2019s device sales in the region, which now account for ~18% of the company\u2019s total sales, down from ~18.8% of total sales China accounted for four quarters ago.<\/p>\n

Therefore, I believe there are some short-term headwinds that Apple faces as it navigates through the second quarter. Management will have to do more to demonstrate how it can re-accelerate device sales. At the same time, management will have to navigate its shareholder capital return goals as well as its net-cash neutral goals carefully.<\/p>\n

Apple\u2019s Valuation and Outlook<\/h2>\n

To value Apple\u2019s target price, here are my assumptions:<\/p>\n