The relationship between Apple Inc. (NASDAQ:AAPL)’s share price and cash flows has been both direct and inverse. A recent trend shows positive correlation but some investors are hoping to sell Apple Inc. (NASDAQ:AAPL) at $450, anticipating that it will hit $450 soon and then drop.
Moreover, at the upcoming G8 summit, the Organization for Economic Co-operation Development (OECD) will probably impose similar tax rates across the board—tech giants like Apple Inc. (NASDAQ:AAPL) won’t have tax havens like those they currently have in Ireland anymore—and this will of course, affect cash flow dramatically.
Apple (AAPL)’s Future Cash Flows
Apple Inc. (NASDAQ:AAPL) will have low future cash flows because it has:
- Planned to use $60bn cash to repurchase shares by 2015
- Already issued $17bn short term debt
Apple Inc. (NASDAQ:AAPL) is issuing more debt to repurchase shares from the market, and the impact of debt increase will make investors demand a higher rate of return. Adding the low cash flows and the possible additional taxes, and we’re looking at a possible drop in price.
Personally, I believe that the tech giant will continue issuing more debt; they would probably go for long term debts too, despite the norm of tech companies avoiding long term debts. They have the leverage to do so, and with excellent ratings for their securities, they are just second to T-bills, so why not use it as leverage and repurchase their own stock? Pump some power into share price and see what happens!
Even if it’s an artificial increase in share price, let’s admit it—Apple Inc. (NASDAQ:AAPL) is a huge company. When they buy back their own stock, they can shake the whole market because of their large market capitalization. They can set the market’s mood.
I believe this strategy will work for Apple Inc. (NASDAQ:AAPL), and we will see a temporary increase in their share price, but only time will tell.
Comparison Between FCF per Share and Market Price
Apple Inc. (NASDAQ:AAPL) is a going concern company; the assumption of terminal value is a key concern in calculating its intrinsic value. The average growth rate of FCF is 67%, which is beyond the market growth rate. In addition, the growth in FCF has moved more than double since last year. Therefore, I use the H-Model to calculate an intrinsic value of $450, as an example.
My assumption is valid for price changes which have been in negative correlation to its cash flows. When Apple Inc. (NASDAQ:AAPL) was the biggest thing back in 2011-2012, the percentage change in FCF was in negative correlation to percentage change in share price.
The graph below shows this relation from September 2011 to June 2012, after which both the changes in share price and the FCF have been moving together (positive correlation); when the change in FCF goes up so does the change in share price.
The predicted lower free cash flows may lower the share price, as both are moving in positive correlation to each other.
Suggestion of a price drop suggests the obvious counter-argument that ‘they can come up with brilliant innovation and create another market just like they did with smart phones and tablets’, but that argument has a flaw. It is based on ‘can’, and the company hasn’t yet.
Apple Shares are Chronic
Apple Inc. (NASDAQ:AAPL)’s shares are chronic in nature, so it may be really easy for them to hit $450 and as soon as the debt burden increases, price will drop. FCF will be low considering their low sales in the last quarter.
Summarizing the whole debate in a few words: assuming that the OECD summit decides that Tech companies need to pay taxes like everybody else, Apple Inc. (NASDAQ:AAPL)’s effective tax rate will be 35% (right now it’s 25%) and their income will reduce by approximately 10%.
Cash flows from operations will be reduced, and that will impact free cash flows. When the free cash flow method is used to calculate intrinsic value, the assumptions are—higher debt, reduced sales, and share buyback. Calculating these factors results in reduced cash flows and a drop in share price.