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Apple (AAPL) reported that its fiscal Q1 sales ended Sept. 30 slumped 0.72%. However, its earnings per share rose 13% and its free cash flow and FCF margins stayed strong. That could be due to a higher mix of services vs. products. As a result, its target price could eventually rise as well.
Here is what happened. Sales fell less than 1% from $90.15 billion in fiscal Q1 2022 to $89.5 billion in Q1 2023. Moreover, full-year sales dropped just 2.8% from $394 billion to $383 billion.
However, services rose 16.3% from $19.2 billion last year to $22.3 billion in the lastest quarter. It now represents about a quarter (24.9%) of total sales, up from 21.2% in last year's fiscal Q1.
This division also produces massive earnings and cash flow. So, over time one could expect this division to rise closer to 50% of sales, especially if total sales slowly decline.
Free Cash Flow and Margins Could Rise
One thing that investors should follow carefully is Apple's free cash flow. In the year ending Sept. 30, 2023, it reached about $100 billion (i.e., $99.6 billion). That was 10.6% lower than the $111.4 billion in the prior 12 months.
However, in the latest quarter, based on data from Seeking Alpha, FCF reached $19.4 billion, down just 6.7% from the prior year's $20.8 billion. That is an improvement from the 10.6% YoY drop.
More importantly, the FCF margin in the last quarter stayed very strong at $21.7% (i.e., $19.4b/$89.5 b). This is likely due to the strong performance of its services division. For example, the services gross margin was 29.1% compared to 29.5% in the prior year quarter.
Moreover, the total FCF margin was very strong at 26.1% (i.e., $100b/$383b) A higher services component could lead to higher total free cash flows for Apple in the long run.
For example, analysts forecast sales this fiscal year will rise close to $400 billion at $396 billion. And for the year to Sept. 2025, revenue is seen by analysts as rising to $420 billion.
Using a higher FCF margin of say 28% could imply free cash flow will rise to $117.6 billion, up 17.6% from the latest 12-month FCF figure.
That could also lead to a higher AAPL price target.
AAPL Stock Could Rise Based on FCF Estimates
For example, using a 3.5% FCF yield, AAPL stock could be worth $3.36 trillion (i.e., $117.6b/0.035). This is up from its present market cap of $2.75 trillion.
That implies a gain of 22.1 in its market cap over the next year. This also leads to a price target of $215.69 (i.e., 22.1% over today's price of $176.65).
Here is another way to look at this. Its present FCF is $100 billion, which represents 3.6% of its $2.75 trillion market value. That is also the same as a 27.5x multiple on its last 12-month FCF. So, if we slightly lower the FCF yield to 3.5% (i.e., increase the multiple to 28.57, since 3.5% is the inverse of that multiple) then the market cap will rise to $3.36 trillion.
This also does not take into account Apple's huge stock buybacks using its free cash flow. That will increase the per-share value even more.
This shows why Apple's free cash flow is so powerful and deterministic about Apple's underlying value. Many analysts and investors are forgetting this as they focus on the latest sales dip.
One Way to Play This is to Sell Short OTM Puts
We discussed this in our last Barchart article on Oct. 1, “Apple Stock Is at 4-Month Lows and Looks Attractive to Value Investors.” Since Apple's dividend yield is so low (0.54%) it makes sense for existing shareholders to enhance their yield by selling out-of-the-money (OTM) puts in near-term expiration periods to gain extra income.
For example, look at the expiration period ending Nov. 24, which is three weeks from today (Nov.3). It shows that the $165 strike price put options trade for 51 cents on the bid. That represents an immediate yield of 30.9 basis points (i.e., 0.309%) over those 3 weeks.
On an annualized basis, if this is repeated every 3 weeks for a year (i.e., 17x), the expected return is 5.25%. In other words, this is a relatively safe way to increase income, especially since the strike price is 6.59% out-of-the-money (i.e., below the spot price).
The bottom line here is that all is not lost with AAPL stock, despite the analysts' complaining about lower sales. Free cash flow will continue to rise over time. That will lead to a higher stock price. Moreover, one way to play this is to gain extra income by shorting OTM puts in near-term expiration periods.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
