Stormclouds gathered around Apple Inc. on Monday after a rare analyst downgrade that came with a warning that investors have been pricing in all of the upside from the company’s next iPhone while ignoring the risks.
Pacific Crest analyst cut their long-held overweight rating on
to sector weight. Shares of Apple were down 0.8% in thin premarket trade.
“At current levels, we believe investors are anticipating an extremely strong iPhone 8 cycle, while giving relatively little weight to risks around gross margins, elasticity, supply issues, or the likelihood for declines beyond the iPhone 8 cycle,” said analysts Andy Hargreaves, Evan Wingren and Tyler Parker, at Pacific Crest, in a note to clients dated Sunday.
Apple has been one of the best performers among U.S. equities this year, with shares up about 34%. That run has been credited with helping drive the current stock-market rally, aided by other big tech names — Facebook Inc.
Google-parent Alphabet Inc.
and Netflix Inc.
Still, Apple shares have struggled since hitting a mid-May, 52-week high of over $152, and that has some concerned that they may have topped out. Not all however –RBC Capital commented in a note to clients last month that Apple could easily become a $1 trillion company in the next year to 18 months, based on strong iPhone 8 demand expectations and big share repurchases.
But therein lies at least one of the problems, said Pacific Crest’s Hargreaves and the team, who see limited upside to current expectations for the next iPhone to dazzle the faithful and investors. Many investors are already looking forward to fiscal 2018 iPhone unit growth in the mid- to high-teens, with expanded gross margins that could push 2018 earnings per share toward $12.
“This would likely require strong growth in sales to new users and extremely strong replacement volume, a combination that seems unlikely,” said Pacific Crest, effectively tossing cold water on that theory.
Analyst expect the decline in sales to new users to resume and expect lower replacement rates to drive iPhone sales down in 2019, after a stronger-than-normal year in 2018. “This combination is likely to drive iPhone unit sales down in FY19, with the magnitude of decline likely being positively correlated to the magnitude of upside in the iPhone 8 cycle. In other words, the better FY18 is, the worse FY19 is likely to be,” the analysts said.
But investors are likely to have learned some lessons from the past and will be quicker to anticipate stagnation in the coming cycle than they were in the iPhone 6 and 6s cycles, said Pacific Crest. In the 6 cycle, Apple’s price/earnings multiple peaked in the second quarter after that phone launched, then compressed by around 50% over the next 12 months.
Multiple compression refers to when shares fail to rise and sometimes even fall on strong earnings, normally caused by investor skepticism over growth prospects.
“In the current cycle, we believe AAPL’s P/E multiple is already nearing peak levels, which suggests the period of compression could also come earlier,” said the analysts.