Apple’s Strong Free Cash Flow Could Boost Its Value

Apple Stock

Apple Inc. (NASDAQ:AAPL) recently reported a slight decline in sales for its fiscal Q1, which ended on September 30, dropping by 0.72%. Despite this, its earnings per share increased by 13%, and the company maintained robust free cash flow (FCF) and FCF margins. This resilience can be attributed to the growing prominence of its services division as a part of its revenue mix, which may lead to an eventual increase in the company’s target price.

Here’s a breakdown of the key points: 

While Apple’s sales experienced a marginal dip of less than 1%, going from $90.15 billion in fiscal Q1 2022 to $89.5 billion in Q1 2023, its full-year sales only decreased by 2.8%, from $394 billion to $383 billion. Notably, services revenue saw significant growth, rising by 16.3% from $19.2 billion in the previous year to $22.3 billion in the latest quarter. This category now accounts for about 24.9% of Apple’s total sales, up from 21.2% in the previous fiscal Q1.

The services division also generates substantial earnings and cash flow, potentially increasing its share of total sales over time, especially if overall sales gradually decline.

A key aspect for investors to monitor is Apple’s free cash flow. In the year ending September 30, 2023, it reached approximately $99.6 billion, marking a 10.6% decrease from the previous 12 months when it was $111.4 billion. However, in the latest quarter, FCF was $19.4 billion, only 6.7% lower than the previous year’s $20.8 billion, indicating an improvement over the 10.6% year-on-year decline. The FCF margin in the last quarter remained robust at 21.7%, likely due to the strong performance of the services division.

This could mean that Apple’s total free cash flow would increase in the long run with a higher share of services in its revenue mix. For instance, analysts predict that sales for this fiscal year will reach approximately $396 billion and, by September 2025, could grow to $420 billion. Assuming a higher FCF margin of 28%, this implies that free cash flow could rise to $117.6 billion, marking a 17.6% increase from the most recent 12-month FCF figure. Such an improvement could lead to a higher price target for AAPL.

Estimating Apple’s Stock Value Based on FCF

Using a 3.5% FCF yield, AAPL stock could be valued at $3.36 trillion, compared to its current market cap of $2.75 trillion. This implies a potential increase of 22.1% in its market capitalization over the next year, resulting in a price target of $215.69, up from the current price of $176.65.

Another way to analyze this is by considering Apple’s present FCF, which stands at $100 billion, representing 3.6% of its $2.75 trillion market value. This translates to a 27.5x multiple on its last 12-month FCF. If the FCF yield is slightly lowered to 3.5%, corresponding to a multiple of 28.57, the market cap would rise to $3.36 trillion.

This analysis does not account for Apple’s substantial stock buybacks funded by its free cash flow, which would further enhance per-share value.

Apple’s free cash flow remains a powerful factor in determining the company’s underlying value, even in the face of concerns about declining sales. Investors and analysts would do well to remember this.

Enhancing Yield with Short OTM Puts

Given Apple’s low dividend yield (0.54%), existing shareholders may consider selling out-of-the-money (OTM) puts with near-term expiration dates to boost their yield. For instance, looking at options expiring on November 24, just three weeks from now, the $165 strike price put options are trading for 51 cents on the bid. This represents an immediate yield of 30.9 basis points (0.309%) over the course of these three weeks.

On an annualized basis, if this strategy is repeated every three weeks for a year (17 times), the expected return would be 5.25%. This approach offers a relatively safe way to increase income, especially given that the strike price is 6.59% below the current stock price.

In conclusion, while Apple faces some challenges, particularly with declining sales, its strong free cash flow is expected to continue to rise, potentially driving the stock price higher. One way to capitalize on this situation is by generating additional income through the sale of short OTM puts with near-term expiration periods.

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