Bank Of America Upgrades Apple To Buy, Says Street Is Too Pessimistic

Shares of Apple Inc. AAPL remain lower by around 26 percent since its all-time highs and BofA recommends investors to be buyers of the pullback.

The Analyst

Bank of America's Wamsi Mohan upgraded Apple from Neutral to Buy with a price target lifted from $180 to $210.

Apple's stock was trading higher by 2 percent at $176.71 per share Monday morning.

The Thesis

Apple's iPhone channel inventory grew by an estimated 4 million units in the fiscal first quarter, Wamsi said in the note. Channel inventory shrunk by a similar amount in the month of January alone and the net lower inventory position could drive some stability in supply chain orders moving forward.

Reports of Chinese retailers lowering iPhone prices for the second time in 2019 is more of a function of foreign exchange fluctuations and the VAT rate reduction, the analyst wrote. The Chinese government reversed course on its prior decision to slowdown gaming approvals in the back half of 2018 and an uptick in new apps bodes could result in services revenue growth.

Street Is Too Pessimistic

Apple's stock near $170 per share prices in negative growth for both the hardware and services business, but Mohan said this view is too pessimistic. A better outlook is for zero terminal growth in the hardware business and a low-single digit growth rate in the services business.

The Street's quick move to revise consensus fiscal 2019 EPS estimates to $11.50 so soon after Apple's preannouncement in January may be "appropriate," but this creates the potential for upside to outer year estimates in fiscal 2020 and fiscal 2021.

Market Share Gains

Apple's iPhone market share in the $900 to $999 price category stands at 93.7 percent and 99.9 percent for phones more than $1,000. After dominating the two price points, management could gain new market share in lower price bands through older models like the iPhone 7.

By gaining new market share, Mohan said Apple will also be able to expand its iOS installed base of users that stands at over 900 million. Apple users tends to be loyal with extremely low churn and this should continue despite the introduction of foldable and 5G phones from rival smartphone makers. In fact, some of the new phones are priced too high like the Samsung Galaxy Fold at $1,980 and the Huawei Mate X at $2,600.

The large installed base could also be further monetized through new services, like a News platform or streaming video service.

Capital Return And M&A

Apple is expected to announce its new stock buyback program in conjunction with its fiscal second-quarter earnings report. The company could announce an increase in buyback activity from its usual $8 billion per quarter to $20 billion over the next two quarters.

Apple's $27 per share of net cash and investments could be used for future M&A deals or help finance new markets like autonomous vehicles, healthcare and gaming consoles.

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