AAPL: Overly Pessimistic Assumptions Mar Stock, Says Bernstein

Sanford Bernstein’s Toni Sacconaghi this morning penned a think piece on Apple (AAPL) shares, pondering the question of why the stock trades at a discount to the market “despite staggering growth.”

Sacconaghi bills this as the first of a two-part report.

Sacconaghi in summary believes that the stock is “not only less expensive that it appears, but that its valuation implies a set of fantastically pessimistic assumptions.”

For one thing, Sacconaghi thinks Apple doesn’t get credit for a more strict approach to paying taxes:

Apple’s tax policy remains relatively conservative, resulting in a tax rate that is 280 bp higher than the average large cap tech company. Moreover, interest rate yields of <80 bp are 200 bp below the average since 2001. Put these together, and Apple’s earnings power is currently understated by 8%.

He also thinks the stock is pricing in a drop of 2% in free cash flow “in perpetuity.

But such a model would mean something very extreme — and bad — would have to happen to Apple’s sales of the iPhone, all else being equal, he writes:

If we assume reasonably conservative assumptions on Apple’s other products (iPad, Mac, iPod, etc) and no pressure to margins, this scenario implies a -27% revenue CAGR on the iPhone from 2012-15. If Apple kept iPhone pricing unchanged vs. FY12 � thereby choosing to grow slower than the smartphone market � its valuation implies iPhone share decreasing dramatically from 18%+ in FY12 to <5% by FY15. Even more strikingly, iPhone unit sales would decrease from an estimated 116M in FY12 to just 45M by FY15 � which appears nearly implausible. Even extremely conservative growth projections for the iPad nevertheless imply greatly reduced iPhone share.

Either that, or Apple’s gross margin would have to collapse by 1,000 basis points (10 percentage points), which he also thinks is unlikely.

Sacconaghi reiterates that Apple shares are his “top pick” and he maintains his price target of $575.

Apple shares today are down $2.92, or 0.7%, at $390.70.

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