Argus on Apple: A Look at the New Models

09/27/2018 5:00 am EST


James Kelleher

Director of Research & Senior Analyst: Technology, Argus Research Corporation

The new iPhones recently announced by Apple (AAPL) generally met expectations that the models would offer incremental upgrades rather than any single “wow” enhancement, notes Jim Kelleher, analyst with Argus Research.

All three new phones offer the facial recognition technology available on last year’s iPhone X, but not last year’s iPhone 8 and 8 Plus. As such, they no longer have a front-of-screen home button.

If you want the home screen on the three new phones, you swipe up from the bottom edge of the phone, or unlock with facial ID. The touch ID biometric is now gone, or least banished to older models still available from Apple.

Like last year’s iPhone X, the displays on the XS and XS Max are edge to edge across the full front of the phone. Both phones are capable of wireless charging with Qi chargers. Both the XS and XS Max have the A12 “bionic” chip with “next-generation neural engine,” according to Apple.

The 7 nm processor is designed to launch apps 30% faster than its predecessor chip. The main (back) camera features dual-lens 12 MP cameras with portrait mode & lighting, depth control, and 4K video up to 60 fps. The major camera upgrade relates to enhanced wide angle and a 6x telephoto lens. The 7 MP front camera is also upgraded.

In addition to launching the three new iPhones, Apple introduced Apple Watch Series 4. It has an upgraded processor, and improved sensors and monitors. Apple has always treated Watch as a fitness device; it now appears to be further positioning its Watch as an aid to overall health. For example, the watch can detect when a wearer has fallen; it then offers a prompt that would allow the wearer to alert emergency services, if needed.

The watch can also perform an FDA-approved electrocardiogram (EKG) test and will alert the wearer to aberrant heart rhythms. The subtle shift from “fitness” to “health” and even heart survivability broadens the target market significantly and should appeal to affluent baby boomers in their retirement years.

We believe that the new phones could prompt a strong upgrade cycle worldwide, which would be felt partly in the current fiscal 4Q18 but most notably in fiscal 1Q19 (ending December 2018). Perhaps more importantly, the variety of available phones at a broad range of price points may enable Apple to finally get unit sales moving higher on an annual basis.

The broad range of phones, in our view, also increases Apple’s ability to compete in every market. That even includes markets such as China, where the iPhone has in recent years lost ground to high-quality, low-price rivals such as Xiaomi and Oppo. The iPhone 8 in the U.S. now starts at $599; the iPhone 7 now starts at $449. While overseas prices are higher, these products are still significantly discounted from recent prices.

Apple is in familiar cadence in introducing new phones in mid-September, just ahead of holiday spending. While the new phones have little “wow” factor, they offer attractive upgrades that will keep them high on consumers’ wish lists. Investors have criticized Apple for its closed ecosystem. That system, however, has the effect of prompting consumers to buy iPads and Macs for system compatibility.

Even more compelling for brand loyalty are Apple’s services, including iTunes, App Store, and iCloud, as consumers do not want the cost and complexity of pulling their media libraries out of the comfortable arms of Mother Apple.

Despite its enormous revenue base, Apple continues to grow phone units and revenue at a double-digit pace. The shares are always at risk from the perception that growth could slow as the law of large numbers catches up with Apple.

The company has mitigated that risk, in our view, with very aggressive shareholder return policies, which will likely remain paramount. Despite the company’s growing largesse, we expect institutional investors to continue to demand more aggressive dividend growth and a larger share repurchase plan.

Although the stock is well ahead of the market and peers year-to-date, we believe that Apple’s positives are not fully reflected in the share price. The stocks continues to look attractive at current levels on measures including relative P/E and discounted free cash flow valuation. We are reiterating our BUY rating to a 12-month target price of $250 (raised from $225).

Our more forward-looking two- and three-stage discounted free cash flow model renders a value north of $340 per share, in a rising trend and well above current levels. Our blended fundamental valuation model points to a price around $280, also in a rising trend.

Appreciation to our 12-month target price of $250 (raised from $225), along with the dividend yield of about 1.3%, implies a risk-adjusted total return in the mid-teens, above our forecast for the broad market and thus consistent with a “buy” rating.

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