By Cornelius Zeeman and Ashin Daya,
Fairtree Portfolio Manager and Equity Analyst
Fairtree’s approach to global investment research involves categorising companies into four main buckets (see Figure 1). Companies can exhibit characteristics of multiple buckets and may shift between them as their business models evolve. Apple provides a compelling case study of this phenomenon, transitioning from a cyclical growth hardware company to a quality defensive, services-oriented technology powerhouse over the last decade. This transformation underscores Apple’s strategic acumen. Despite debates over Apple’s premium valuation (refer to Figure 2 below), the company exemplifies how to deliver substantial shareholder value even in an ex-growth environment.
Figure 1: Fairtree’s company classification buckets
Source: Fairtree
Figure 2: Apple’s price-to-earnings valuation multiple
Source: Fairtree, Bloomberg
Apple’s entry into the handset market.
In 2007, Apple revolutionised mobile phone technology with the iPhone launch. The device combined a phone, iPod, and internet communicator into a sleek, multi-touch device. The iPhone’s introduction marked a pivotal moment in technology, setting new standards with features like Visual Voicemail and a revolutionary touchscreen interface.
As a result, iPhone sales soared in the early years after its launch. In 2007, at the time of the iPhone’s debut, Mac computers accounted for the largest share of Apple’s revenue at 42%, followed by the iPod at 30%. Since then, iPhone sales growth has slowed, with notable spikes driven by technological advancements (refer to Figure 3). The 2015 surge was due to the new plus-sized form factor, the 2018 spike came from the release of OLED screens, and the 2021 growth was fuelled by the introduction of 5G devices. These innovations have consistently reignited consumer excitement and boosted sales.
Figure 3: iPhone sales as the key growth driver in the early years after launch
Source: Fairtree, Company Filings, BofA estimates
The ex-growth hardware industry.
The smartphone, tablet, and PC industries experienced explosive growth from 2008 to 2013 as consumers adopted these revolutionary devices for the first time. However, this initial surge has since slowed, and industry volumes have declined. Most consumer demand has shifted towards replacements, with longer replacement cycles becoming the norm, as shown in Figures 4 and 5 below.
Figure 4: Hardware industry unit sales
Figure 5: The elongated hardware replacement cycle
Apple services.
Despite sluggish growth in the hardware industry, Apple has achieved an impressive compound revenue growth rate of 8% over the past decade. Net profit growth has been even more remarkable at 10%. This success is partly due to Apple’s exceptional innovation and the launch of new premium models, which have driven revenue growth beyond unit sales.
More importantly, Apple has capitalised on its expanding base of installed devices, as shown in Figure 6, to boost sales of high-margin services, further enhancing profitability. Apple’s services business includes the App Store, Apple Music, iCloud, Apple Pay, AppleCare, Apple TV+, and Apple Arcade. These services come at a higher gross profit margin than the hardware business, as shown in Figure 7, and continue to increase due to the fixed-cost nature of the services business and the growing installed base.
Figure 6: Apple’s installed base
Source: Company filings, Morgan Stanley Research
Figure 7: Apple’s gross profit margins by reportable segment
Source: Fairtree, Company filings
Apple’s quality fundamentals.
Over the past decade, Apple’s net profit has compounded at an impressive rate of 10%. Remarkably, Apple has converted 100% of its earnings into free cash flow during this period. This efficiency stems from Apple’s strategic approach to manufacturing – outsourcing to contract manufacturers to transform high fixed costs into variable expenses.
By 2012, Apple had accumulated a net cash balance equivalent to a quarter of its market capitalisation at the time and began returning capital to shareholders through dividends and share buybacks. The 2018 US tax reform enabled Apple to repatriate a significant portion of its overseas profits, significantly boosting its share buyback programme. Since then, Apple has repurchased over US$500 billion of its shares, averaging US$77 billion annually. This has allowed Apple to reduce its shares outstanding by 40% over the past 10 years and grow earnings per share at a compound growth rate of 16% over the same period. In its latest earnings release, Apple announced the largest incremental buyback authorisation in US corporate history, totalling US$110 billion.
Figure 8: Apple’s capital allocation history
Conclusion.
Apple’s remarkable transition demonstrates that a company can thrive even in the face of sluggish growth. Their success story is fuelled by a loyal user base, relentless technological innovation, strong pricing power, and a strategic focus on maximising monetisation opportunities from their expanding installed base through their diverse array of service offerings. Apple remains a formidable force in the global technology landscape, demonstrating that adaptation and innovation are key to sustained success in an ever-changing market environment.
Disclaimer:
Fairtree Asset Management (Pty) Ltd is an authorised financial services provider (FSP 25917). Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CISs are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. Performance has been calculated using net NAV to NAV numbers with income reinvested. There is no guarantee in respect of capital or returns in a portfolio. Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45 of 2002). For any additional information such as fund prices, fees, brochures, minimum disclosure documents and application forms, please go to www.fairtree.com
