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Apple (AAPL) produced free cash flow (FCF) margins that peaked last fiscal year at over 28%. In its most recent FY ending Sept. 2023, they dropped to just 26%. And in the latest fiscal quarter, FCF margins fell to 21%.
Does this mean that Apple's performance has peaked? Could that lead to a peak in AAPL stock or flat performance over the next year? If so, what is the best way to play the stock going forward?
This article will discuss some alternatives.
FCF Margins May Have Peaked For the Near Term
Analysts and investors should be aware that the company's internal cash generation seems to have come down from its peaks.
For example, for the year ending Sept. 2023, Apple produced almost $100 billion in FCF. I showed this in my last article on AAPL stock in Barchart on Nov. 5, “Apple Could Still Be Worth More Due to Its Strong Free Cash Flow.”
That represented 26.1% of its total revenue of $383.3 billion. But last fiscal year, Apple made more FCF and its FCF margins were higher. For example, it generated $111.4 billion in free cash flow (i.e., 11% more than in 2023).
Moreover, based on its 2022 FY revenue of $394.3 billion, Apple's prior FY FCF margins were 28.3%. In other words, not only did FCF fall 11%, but its margins dipped from 28.3% to 26.1%, a drop of 7.77%.
That's not good. The only bright spot was that its services division margins increased over that period.
However, in the latest quarter, the company's total FCF margins dipped to just 21.7% (i.e., $19.4 b FCF/$89.5 sales). If that lower FCF margin persists through this coming fiscal year, investors might see a dip in AAPL stock.
Best Case Scenario
Let's not go there just yet. For example, the company's Q4 is typically very weak, especially compared to the current quarter. So, let's assume that the average 26% FCF margin lasts throughout FY 2024.
Here's how that puts Apple's financial outlook. First, of all, analysts project revenue this year will reach just under $400 billion, according to Seeking Alpha.
So, if we apply a 26% FCF margin to this estimate, FCF could reach $104 billion. This is about 4% higher than the $100 billion FCF generated by Apple in 2023.
It also implies that assuming the stock's 30x FCF multiple stays the same, AAPL stock might rise only about 4%. In other words, the target price could be only about $197 (up 4% from today's price of $189.43 per share).
And that is a best-case scenario. Let's not worry too much about a worst-case scenario. Instead, let's figure out a way to play a flat stock price over the next year.
Short Near-Term OTM Calls and Puts
Given that Apple has such a small dividend yield (about 0.50%), existing shareholders should look for ways to enhance their income. One play is to repeatedly sell short out-of-the-money (OTM) puts and calls in near-term expiration periods.
For example, look at the expiration period ending Dec. 22, which is 28 days from today. The $200 strike price puts trade for 45 cents on the bid side. That represents a covered call yield of 0.238% for just one month until expiration.
That is over half of the annual 0.50% dividend yield. If this is repeated every month, the annualized expected return is 2.86%. That is a more normal income yield than the dividend yield.
Note that this strike price is 5.43% over the present spot price. So, if AAPL rises to $200 or higher the investor can also make a potential capital gain. However, their shares would be sold (i.e., 100 shares per call contract) at $200, incurring a potential realized gain.
Another way to play this is to sell short OTM puts. This does not involve any forced selling of shares. In fact, the opposite occurs. The idea is to sell a put strike price that is well below the present price. Even if AAPL stock falls to the strike price the investor just has to purchase more shares.
For example, for the same expiration period, the $175 strike price puts, which are over 7.75% below today's price, trade for 38 cents. That represents an immediate yield of 0.217% (i.e., $0.38/$175) for the investor.
Note that I divided the income by the strike price, not the spot price. This is because the investor must secure $175 x 100, or $17,500 in cash or margin with the brokerage firm.
That is not equal to the spot price. In other words, this is a cheaper way to play the short-income strategy compared to covered calls. This shows that shorting puts have almost the same income yield but have a bit less risk. In this case, the strike price is further out-of-the-money than the covered call play.
The bottom line is that assuming AAPL stock stalls over the next year, one way for existing shareholders to play the stock is to short OTM puts and calls.
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.
