(By Mani) Shares of Apple Inc. (NASDAQ: AAPL) have dropped 14 percent in the past three months, falling from $700 to $589 despite the iPhone 5 selling like hot cakes. Investors are concerned over margins and sent shares near their lowest P/E and EV/FCF levels in five years. However, technical indicators and fundamentals show that the shares are set for an upswing in the long-term.
Apple shares are trading at 12 times its 2013 consensus earnings estimates while its EV/FCF stands at 17 times. Meanwhile, the valuation looks cheap with a current return on invested capital (ROIC) north of 30 percent and double-digit revenue growth prospects.
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In the near-term, earnings momentum could slow down a bit, which in turn may help the multiples.
"We expect earnings momentum to bottom in the December period. The next four quarters in our model reflect a bottom then re-acceleration: -5 percent, 9 percent, 33 percent, 46 percent," UBS analyst Steven Milunovich wrote in a note to clients.
The year-over-year growth of earnings in the four quarters of fiscal 2012 showed deterioration of 116 percent, 92 percent, 20 percent, and 23 percent. The multiple decline may be related to the lack of recent upside earnings surprises. Apple consistently beat estimates until the last two quarters. The past two sets of results prompted the sell-side to reduce expectations.
The question now on investors' minds is margins. Apple guided the gross margin from 40 percent in September to 36 percent in December, mostly due to start-up costs associated with the fact 80 percent of revenue is coming from new products.
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"Our view is that the gross margin can return to the low-to-mid 40s as products come down the cost curve and iPhone's contribution to revenue stays above 50 percent," Milunovich noted.
Analysts see an opportunity for upside surprise given a pattern of reporting two big quarters followed by two weaker quarters with product announcements weighed toward fall. Pent-up demand for the iPhone 5 and interest in the iPad mini are likely to be catalysts for an earnings surprise.
Meanwhile, the stock's decline has stirred investor anxiety, but this correction should be viewed as a base for a long-term uptrend. For the first time since the market lows of March 2009, the stock has broken through its 50-week moving average while dipping into oversold territory.
"Despite the decline, Apple's four-year trend line remains intact, and the net retracement hovers around first (23.6 percent) Fibonacci support at $560. Some indicators, particularly a key reversal day last week, suggest a return to positive momentum," Milunovich said.
The rise to $700 per share in 2012 marked a meaningful change in the stock's trajectory, leaving the stock up nearly 75 percent on a year-to-date basis in mid- September when the iPhone 5 was introduced.
The old adage "sell on the news" seems to apply with the stock giving back slightly less than half the year's gain. Some of the pullback could be explained by the expected change in the US capital gains tax rate from 15 percent to 20 percent. Eighty-five percent of Apple's shareholder base is domiciled in the US with just under 30 percent held directly by retail, according to market data compiled by Bloomberg,
Relative to other tech stocks, Apple remains firmly above longer-term trendlines as well as intermediate support levels. Although the stock has lost some relative ground, it remains above relative trendline support vs most large cap tech names, including Google, Inc. (NASDAQ:GOOG), Microsoft Corp. (NASDAQ:MSFT), Intel Corp. (NASDAQ:INTC), Cisco Systems, Inc. (NASDAQ:CSCO), and Qualcomm, Inc. (NASDAQ:QCOM).
"Apple has held its ground against the greater market though it has broken below intermediate support, in part due to the S&P 500's relative outperformance over both growth and tech indices in recent weeks," Milunovich wrote.
In the past week, sentiment has begun to show some life starting with a key reversal day on Nov. 19 following a candlestick hammer the previous day. From the hammer, the stock gapped higher at the open and finished higher on the day while reaching its highest volume since March.
The stock remains below its 200-day MA though it has held above its reversal day highs. This stabilization along with strong volume patterns suggests that the stock has put in its corrective low for now.
Moreover, the stock has a price pattern that has played out in other iPhone cycles, in which the stock corrects after introduction then rallies.
"We believe that valuation, earnings momentum, and technical factors suggest that it is a good time to be building positions into the new year," Milunovich added.