/Apple%20Logo%20on%20Store%20Front.jpg)
Apple (AAPL) stock tumbled 4.8% on Friday, June 4, to $181.99, and is now down $14.46 or 7.36% from its July 31 peak of $196.45. This drop came after Apple's June quarter earnings on June 3 after-hours showed iPhone sales fell for the 3rd time.
But the market seems to be overlooking massive Apple's free cash flow (FCF) and its growth, which is still strong. This could potentially make AAPL stock a buy, especially if FCF growth stays strong.
Free Cash Flow Stays Strong
Apple said that its services revenue reached a new all-time high, up 8.2% year-over-year. This helped ameliorate the overall 1% drop in revenue to $81.8 billion, and especially the drop in iPhone sales, which are 48.5% of its overall sales.
The problem with iPhone sales growth is that everyone has a smartphone and people are holding on to their expensive iPhones longer.
Nevertheless, as The Motley Fool pointed out, its service's profit margins are extremely high, at over 70%, compared to the 35.5% product margins. This is what is powering its substantial operating cash flow as well as free cash flow growth.
For example, in the latest fiscal Q3 ending July 1, Apple generated an FCF of $24.287 billion. This was 16.8% higher than the year-ago FCF of $20.79 billion. (This information is available from Seeking Alpha's quarterly operating cash flow figures and deducting each quarter's capex spending.)
As a result, the FCF margin during the Q3 ending July 1, was 29.7% (i.e., $24.3 b/$81.8 billion sales). But over time this FCF margin will likely rise.
Therefore, Apple's free cash flow looks to be sustainably strong, given its high service margins as well as its growth rates. So, AAPL stock could be cheap here. Here's why.
Projecting APPL Stock Based on FCF
For example, let's use analysts' forecasts of $407.7 billion for next year ending Sept. 2024. Assuming services revenue grows to 30% of sales, up from 25.9% in Q3, that means it could hit $122 billion. Now, if we assume that its FCF margin for services rises to 72%, that puts its FCF, before product sales at $88 billion.
If we assume that product sales produce an FCF of $101 billion (i.e., 70% x $407.7 billion x 35.5%), FCF could start to approach $190 billion next year. If we lower this amount by 15% since we assume operating margins are the same as FCF margins, FCF could be $161.5 billion.
That means that at a 5% FCF yield (i.e., 20x FCF), Apple could end up with a $3.23 trillion market value. That is 13.3% higher than its present market cap of $2.85 trillion.
Moreover, at a 4.0% FCF yield (i.e., 25x FCF) its market cap could be $4 trillion (i.e., $161.5b x 25 = $4,035 billion). That is 41.7% higher than today's market cap.
In other words, with a reasonable FCF margin and growth rate, we can project that APPL stock could rise between 13.3% to 41.7% higher, or $206.19 to $257.88 per share.
Buybacks Will Enhance Shareholders' Returns
And keep in mind this does not include any extra benefit that APPL stock gains from Apple's huge buybacks.
For example, in its latest quarter, Apple spent $24 billion on buybacks and dividends. This includes the $19.8 billion it spent on share repurchases, based on Seeking Alpha figures.
That works out to $80 billion annualized or about 2.8% of its existing $2.85 trillion market cap.
In other words, APPL stock looks cheap here, based on both its powerful free cash flow growth, its services division growth, and its massive buybacks.
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.
