Automatic Data Processing, Inc

Apple Inc.

Note: This report contains substantially new material. Subsequent reports will have changes highlighted.

Reason for Report: 2Q18 Earnings Update

Prev. Ed.: Mar 16, 2018; News Update and Changes in Estimate

Firms’ Recommendations: Positive: 51.7% (15 firms); Neutral: 44.8% (13); Negative: 3.5% (1) Prev. Ed: 14, 13, 1

Firms’ Target Price: $195.17 (↑$5.65 from last edition; 23 firms) Firms’ Avg. Expected Return:3.1%

Note: A flash update was done on May 1, 2018 (2Q18 Earnings Update)

Note: Though dated May10, 2018, the data in the tables below are as of May 7, 2018.

Note: The tables below (Revenues, Margins and Earnings per Share) contain material from fewer brokers than in the Valuation table. The extra figures in the Valuation table are taken from reports that did not have accompanying spreadsheet model.

Note: We do not have access to firm reports presenting Sell rating on AAPL

Executive Summary

Apple Inc. (AAPL) designs, manufactures and sells personal computers (Macs), mobile communication devices (iPhone) and tablet PCs (iPad), as well as related software, services, peripherals and networking solutions.

Key factors for evaluating an investment strategy for Apple are as follows:

• Strong brand value of Apple products, particularly iPhone, drives growth.
• Huge cash balance provides it the necessary flexibility to develop new products.
• Share repurchase and dividend program make the stock more attractive to investors.

Competition: Apple competes in these primary industries within the technology sector — smartphones, PCs and tablets. The company's share of the PC market remains small compared with industry leaders like Hewlett-Packard, Dell, Toshiba, Lenovo and Samsung, despite the decent demand for Mac. In the smartphone segment, Apple faces significant competition from Google’s Android-based handsets that are manufactured by HTC, Huawei, Lenovo, LG, Samsung and Xiaomi. In the tablet market, Apple faces stiff competition, primarily from Samsung and Amazon. Furthermore, Apple Pay is also likely to witness stiff competition from Samsung’s LoopPay, eBay’s PayPal, Google Wallet and Amazon Payments among others. Additionally, the company has forayed into smartwatch and digital streaming industries with its offerings like Apple Watch and Apple TV, wherein the existing players are likely to pose stiff competition for this tech giant.

Of the 29 firms covering the stock, 15 provided positive ratings, 13 were neutral while 1 firmhad a negative outlook. Target prices range from a low of $161.00 to a high of $235.00,with the average price being $195.17.

Bullish (Buy or equivalent) — 15 firms or 51.7%:These firms believe that Apple’s expanding ecosystem gives it a significant edge over its peers. The anticipated launch of three new“X-Gen” models in fall 2018 is expected to improve upgrade rates. The firms also remain highly optimistic about the company’s high-margin services segment.Apple is witnessing significant momentum in Apple Pay, Apple Store and Apple Music. Moreover, the firms are of the opinion that Apple Watch is poised to become one of the significant contributors to total revenues going ahead. According to the firms, the company continues to benefit from the switching of Android users in some key markets like China and the United States. A loyal customer base is an added advantage. In addition, Apple is also taking a number of initiatives to strengthen its presence in growth regions like India, which can become a key long-term driver going ahead. Robust liquidity and a strong capital return plan are the other big positives.

Cautious (Neutral or equivalent) — 13 firms or 44.8%:These firmsbelieve that the current iPhone cycle will continue to remain sluggish.Moreover, the firms believe that iPhone sales will be marred by the increasing replacement cycle of smartphones. Also, Apple’s performance is dependent on the level of consumer spending in the market in which it operates, and is, therefore, susceptible to macro-economic fluctuations. In addition, increasing competition from well-known players such as Samsung, and other Asian vendors, including Huawei, Xiaomi and Lenovo, remains a concern. Lower-priced offerings from such companies are negatively impacting Apple’s market share. Nonetheless, these firms consider Apple’s ongoing capital return program as a positive. They believe that the company’s $100 billion share repurchase plan and 16% increase in quarterly dividend will be the next catalysts for the stock.

Bearish (Sell or equivalent) — 1 firm or 3.5%

Conclusion: Overall, the firms believe that Apple is becoming increasingly well positioned to tap a larger number of enterprise customers. To ensure a high-quality buying experience for its products where service and education are emphasized, the company has expanded and improved its distribution capabilities by opening its own retail stores in the United States and internationally. Nevertheless, the firms believe that intensifying competition and delay in the launch of an innovative product remain overhangs on the stock.

May 10, 2018

Overview

Based in Cupertino, CA, Apple Inc. (AAPL) is popular for its innovative products. The company generates revenues primarily from the sale of hardware, software, third-party digital content and applications, and service and support contracts. The company’s hardware offerings include the Macintosh personal line of computers (desktop and notebook), iPod, iPhone and iPad. Its software offerings include iOS (which powers the iPhone and iPad) and OX operating systems as well as iCloud. The company also sells digital content and applications through its iTunes Store, App Store, iBookstore and Mac App Store. Apple sells products primarily to retail consumers, small and mid-sized business establishments, and education, enterprise and government customers.

From 1Q15 onward, Apple changed its reportable operating segments to iPhone, iPad, Mac, Services and Other Products.

Key investment considerations as identified by the firms are as follows:

• Apple has a strong brand name and a loyal customer base
• Ramping up iPhone sales in multiple geographical regions has set up a strong recurring revenue stream combined with potential cross-selling opportunities for Mac. iPhone continues to generate maximum profit for Apple
• Apple is also now focusing on other Products and Services to boost the top line
• Apple has an excellent cash position, which it uses to make accretive acquisitions as well to make share repurchases and dividend payouts. These enhance shareholder confidence in the stock

• PC, consumer electronics hardware, software and other aspects of Apple's business are characterized by intensifying competition
• Apple is entangled in patent litigation cases in several countries. These cases are not only time consuming, but also adversely affect the company’s reputation and operational results
• Apple is vulnerable to component pricing and is affected by supply chain constraints

Note: AAPL’s fiscal year ends on Sep 30. Fiscal references differ from the calendar year.

ay 10, 2018

Long-Term Growth

Apple’s loyal customer base, innovation capabilities, impressive resources, strong cash allocation plan and reasonable valuation give it an edge over its competitors and help it to generate decent growth and profitability over the long term.

iPhone is one of the primary growth drivers for the company. In Nov, 2017, Apple launched iPhone X, the first iPhone to feature end-to-end curved OLED display with a facial recognition technology that unlocks the phone as well as helps to make secure payments via Apple Pay.

The device supports wireless charging and is resistant to microscopic dust and water. It also has the A11 bionic chip. Apple added that with the new A11 bionic chip, augmented reality games and apps “reach a new level of fluidity andrealism.”The Home button has been done away with. Users will just have to swipe up to access the home screen.

The iPhone X has 5.8” Super Retina Display with 2046×1125 resolution and 458 PPI. The camera is way better than the earlier iPhones. The iPhone X has 12 MP dual cameras with faster sensors and f/1.8 and f/2.4 apertures.Then there is also animoji, an app that deploys 3D technology to create emojis that imitate the users’ expression.

Notably, Apple is benefiting from the switching of Android users in some key markets. The company is also likely to benefit from its robust installed device base, which crossed the 1.3 billion mark in January 2018. The iPhone X along with iPhone 8 and iPhone 8 Plus should also help Apple keep the momentum going.

Additionally, the company is now focused on developing innovative products in order to generate new revenue streams. This diversification is expected to benefit the company in the long run.

Strong adoption of Apple Pay is a key positive. The service has been expanded to 21markets. It garnered huge success in Tokyo. The company plans to launch it in Norway, Poland and Ukraine in the next several months. In March, the company launched Express Transit with Apple Pay in Beijing and Shanghai.

At WWDC 2017, the company announced that Apple Pay will support P2P payments.

At its Sep 12 event, the company announced Watch OS3 with a built in cellular.Per NPD’s latest Worldwide Quarterly Wearable Device Tracker report, Apple was the leading player in the wearables market in 2017, courtesy of Apple Watch.The availability of more features in Watch OS 4.2 coupled with the launch of AirPods and HomePods should help Apple to further increase its market share.

Further, Apple is now foraying into original programming which is considered by the firms as an attempt at boosting Apple Music’s subscriber base.

Furthermore, the company has also been making some important developments for its voice assistant, Siri, which will now be integrated with iOS 11 to enhance its utility. The operating system now features a more natural-sounding voiceover for Siri, which is now capable of translation. The company released iOS 11.3 in March with expanded augmented reality (AR) features.

The firms believe that over the long run, Apple, with its new offerings, will also be able to leverage the Internet of Things (IoT) market, which is expected to grow exponentially, given the rising demand for connected/automated devices, appliances and automobiles. Per an IDC report, the global IoT market is projected to reach about $1.3 trillion in 2020 at a CAGR of 15.6%. Apple has already started expanding its offerings into wearables, home appliances and is possibly preparing to enter the automobile market as well.

Besides, Apple’s education-focused event on Mar 27 was an enthralling one with the company unveiling new software as well as hardware updates, aimed to strengthen its footprint in the education technology market. At the event, Apple announced a feature-rich iPad, a cheaper third-party stylus, an update to its iWork suite of productivity apps, a new Schoolwork application and “Everyone Can Create” initiative.

Furthermore, Apple is likely to benefit from the rising middle class population with increasing purchasing power in emerging markets, including India. This, combined with declining competition in the high end of the market, will help it grow in the long run. Additionally, the company still has a lot of scope to drive growth, as evident from its low penetration rates. Moreover, it has ample resources and decent margins that can support the promotional initiatives required to tap new markets.

Apple is also working on developing technologies such as artificial intelligence(AI) and augmented reality/virtual reality(AR/VR), which are fast emerging as lucrative business opportunities. The company’s interest in the autonomous car project is understandable as this is now being labeled as a big business opportunity. The firms are also optimistic about Apple’s $1 billion investment in China’s ride-hailing company – Didi Chuxing. This move will allow the company to get some important data on connected cars while allowing it to understand some important aspects of the Chinese market. Apple is also planning to replace Intel’s chips used in Mac computers with its own from 2020.

The firms believe that Apple’s partnership with Accenture, IBM, Cisco and SAP will bolster its enterprise mobility penetration in the long run. They believe that the new iPhones with large screen sizes will help in drawing more customers, which, in turn, will drive top line growth going forward.

Also, most of the firms believe that Apple will face significant competition from several hardware vendors, particularly from producers of low-end products. Management commented that it is not willing to sacrifice functionality for price and the firms believe this will benefit Apple in the longer term. The company has been concerned with its reputation for producing high quality products, which, the firms believe, has served it well.

May 10, 2018

Target Price/Valuation

Provided below is a summary of valuation and ratings as compiled by Zacks Digest Research:

Risks to the target price include intense competition in the global markets from companies such as Hewlett-Packard, Dell, Nokia, Motorola, etc.; high dependence on a few successful products; dependence on third parties for outsourced services; foreign exchange risks; risk of iPhone cannibalizing iPod demand and retail store operational risks.

Recent Events

On May 10, 2018, Apple announced the cancellation of itsdata center project planworth EUR 850 million in Ireland over delay in approval process.

On May 9, 2018, there were reports that Apple is planning to sell video subscriptions via its TV app.

On May 1, 2018, Apple reported its 2Q18 results. The highlights are as follows:

• Revenues increased 15.6% y/y to $61.14 billion
• Adjusted EPS increased 30% y/yto $2.73

On Apr 11,2018, Apple announced that the music streaming service, Apple Music, hit 48 million subscribers. The company also promoted Oliver Schusser as vice president of Apple Music and international content.

On Apr 9, 2018, Apple unveiled red iPhone 8 and 8 Plus, as part of the company’s partnership with the Red project to raise funds to fight AIDS/HIV.

On Apr 5, 2018, Apple revealed to TechCrunch that it is likely to unveil upgraded Mac Pro computers in 2019.

On Apr 4, 2018, Apple rolled out its mobile payment platform Apple Pay in Brazil, making it the first South American market to get the service.

On Apr 2, 2018, Bloomberg reported that Apple is planning to replace Intel’s chips used in Mac computers with its own from 2020.

On Mar 27, 2018, Apple announced a feature-rich iPad, a cheaper third-party stylus, an update to its iWork suite of productivity apps, a new Schoolwork application and “Everyone Can Create” initiative.

On Mar 19, 2018, per a Reuters report, which quoted Bloomberg, Apple is developing its own MicroLED device screens at a secret plant in California.

On Mar 15, 2018, Apple launched a new website that provides tips and tutorials to parents about how they can better monitor their children's activities on its devices like iPhones and iPads.

On Mar 14, 2018, Apple sought European Union (EU) approval for the Shazam deal. EU antitrust authorities will decide by Apr 23 whether to clear the deal.

On Mar 13, 2018, Apple announced it will host its annual Worldwide Developers Conference (WWDC) in San Jose over Jun 4–8.

On Mar 12, 2018, Apple management announced that Apple Music has hit 38 million paid subscribers. Apple also announced the acquisition of Texture, a digital magazine service that offers unlimited access to a broad catalog of magazines for $10 per month. Texture is owned by Next Issue Media, a joint venture between prominent magazine publishers Conde Nast, Hearst, Meredith, NewsCorp, and Rogers Media.

Revenues

According to the 2Q18 press release, net sales increased 15.6% y/y to $61.14 billion. Apple benefited from robust iPhone and Services segment revenue growth.

According to Apple, iPhone X has been its top-selling phone every week since launch in November 2017. Apple mentioned that the device was the most popular smartphone in China in the reported quarter. Another iPhone model was also among the top three in the country.

Apple Services (15% of sales) revenues of $9.19 billion were backed by record growth in App Store, Apple Music, iCloud and AppleCare revenues in the quarter. Management stated that active installed base for all devices grew in double digits on a y/y basis.

Wearables Robust Performance

Total revenues from wearables, which include Apple Watch, Beats and AirPods, increased almost 50% y/y. Unit sales of Watch and AirPods set a new high in the 2Q18.

Apple Watch revenues showed double digit y/y growth. The company launched Apple Watch Series 3 with a cellular connection in Mainland China, Hong Kong and Thailand with many more markets under way. The availability of more features in Watch OS 4.2 makes the product more appealing.

The company added that AirPods are gaining popularity and it is striving hard to meet its robust demand. HomePods (launched in February), which are currently available in the United States, United Kingdom and Australia, will be introduced to more global markets shortly. The company is also adding new features to the smart speaker.