Financial Analysis of Apple Incorporated Essay Example

started. Their products include mobile communication such as the iPhone, media devices such as the iPad, personal computing products such as the Mac, and portable digital music players such as the iPod. Furthermore, what Apple managed to do was to merge several of these products resulting in new lines of the already existing products. For example, an iPhone now includes a web browser like the Mac and a music player like an iPod. All these products run on Apple exclusive operating system software (iOS) that is always updated with the latest technology (Inc., 2012).

Other services offered by Apple include an online store (iTunes Store) that allows the customers to buy movies, music and books and another online store, Mac App Store that allows the customers to download, purchase or rent digital content or applications. Finally, a recent service offered, is what is known as iCloud. This is simply a virtual service that allows the customers to store any type of file (pictures, music, digital documents, etc.) all on a ‘cloud’, which can be accessed at anytime and anywhere (Inc., 2012).

Market Share and Distribution

Throughout the years, Apple Inc. has created a wide range of customers through making its product as readily available and user-friendly as possible. Apple’s products are appropriate for various industries: educational, artistic, business and personal. This has gained Apple customers coming from various backgrounds. Apple products can be found in retail stores, online stores, retailers and value-added re-sellers.

Apple works on training and informing their salespersons about every detail of their product and/or service they are selling because they believe that the customer’s experience is

very critical. They ensure that the targeted customers are aware of the advantages of Apple’s products over the products of the competitors, which is primarily shown with the high-quality sales and after sales support experience. This is shown effective in Apple’s strong attraction of new customers and by maintaining the already existing ones (Inc., 2012).

Competition

The evolution of technology can be seen through the continuous launch of new products in the market. The different Apple products that have been introduced to the market were always attacked by the competitors’ similar product. The level of imitation has increased in the computer industry in order to be in level with the market’s benchmark. Many of these products are simply an imitation to what has been produced by Apple. Apple, as well as all the other companies of the same industry, is facing constant pressure to try to be more innovative in their production. In fact, Apple is focusing on expanding its market opportunities; and it tackles its competitors by its products’ pricings, product design and technology and the frequency of launching a product (Inc., 2012).

Research and Development

As was previously mentioned in section 2.3, the industry that Apple is primarily in, is constantly going through technological advances. For that reason, and in order for Apple to compete successfully in the market, Apple is continuously investing in its research and development department. The total research and development expenses were shown to have increased in the past three years (Inc., 2012).

Qualitative Analysis

Apple’s Business Model

Apple initially started with the production of computers. Nowadays, Apple not only manufactures computers,

it also designs and markets mobile communication and media devices, portable digital music players. Another part of Apple’s business includes the selling of a variety of software, services, peripherals, networking solutions, and third-party digital content and applications. The products and services are sold worldwide through retail stores, online stores, and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers, and value-added resellers (Inc., 2012).

Business Strategy

Loyal customers are always looking forward to Apple’s next invention. This is the case because of the commitment that Apple has towards providing the best customer experience through its constant innovative hardware, software and service that bring a high level of customer satisfaction. As part of its business strategy, Apple continuously works on investing in research and development, not only to maintain customer satisfaction level, but to also maintain the company’s market share in the highly competitive industry of technology. In other words, Apple was able to differentiate its products from many others in the market.

Another part of Apple’s business strategy involves the customers’ personal experience with using the products. Any single customer would be happy to pay the “extra money” for Apple’s distinct products and services in return. Apple made it very simple for the customers to make their own downloads from their wide libraries of music, books and applications. This is in fact one of the main advantages that Apple has over many of its competitors. Any company relying on a differentiation strategy needs to constantly come up with special features that would attract customers to its products and services more than what other competitor companies have to

offer (Inc., 2012).

Corporate Governance

The company has seven directors and one chairman of the board and a total of three committees: Nominating, Compensation, and Audit committee. The Nominating committee consists of two members (Millard Drexler and Al Gore) and a chair (William Campbell). This committee, from its name, assists the Board in selecting the individuals that are qualified enough to become directors, and make any decision or discussion related to the Board and its committees as well as provide supervision to the company’s Corporate Governance Guidelines; making sure they are being implemented. The members of the Nominating Committee meet about four times a year (Apple, 2013).

The Compensation committee accounts for reviewing all the company’s compensation factors that are being offered to its executive officers as well as its CEO. The compensation factors include the equity compensation plans and the compensation of the Board. This committee is formed of two members (Millard Drexler and Al Gore) and a chairman (Andrea Jung) and they meet approximately five times a year (Apple, 2013).

The Audit committee happens to be formed of the more members that the Nominating and the Audit committee. The chairman of the committee is Ronald Sugar and the members are William Campbell, Robert Iger and Arthur Levinson. The Audit committee’s role is to examine the services performed by the Apple’s accounting firm and internal audit department. Evaluations of the company’s accounting policies and system of internal control are made and discussed as well as the financial transactions and the enterprise risk management. The Audit committee consists of three members and a chairman. The members and the chairman meet

up together around nine times a year (Apple, 2013).

Quantitative Analysis

Sales and Profitability

Sales in 2012 stood at USD 156Bn (+45%) compared to USD 108Bn in 2011, the major element behind the increase is the portables and peripherals segment which increased by approximately 45% from 2011 figures. iPhone and iPad were the main drivers behind the growth contributing to over 72% of the total net sales. This draws our attention to the product concentration risk the company is exposed to, as to the fact that iPhone and iPad are considered to be the cash-cow of the company and if it couldn’t sustain its competitive advantage and market share, it will suffer from financial distress.

To start with the gross margin, the company recorded 43.9% in 2012, 40.5% in 2011, and 39.4% in 2010 which is superior to that of Samsung’s gross margin of 35.5%. It’s worth noting that the company is exercising its bargaining power construed from its brand name (Inc., 2012). On the other hand we notice that the company is conservative relative to its budgeting and cost structure as reflected on the operating margins which is steadily aligned with the level of sales (35.3% in 2012); thus the company is considered to be using a cost structure that is flexible and controllable in cases of sudden market changes. A net margin (excluding income tax) of 35.6% in 2012 up from 31.6% in 2011 and 28.2% in 2010 is a solid indicator for the company’s liquidity position as there’s no financing cost being paid to banks rather relying on its positive working capital (Inc., 2012) .

Return

on capital employed is steady throughout the 3 years ranging from 33% in 2010 to 38% in 2011 and ended up with a slight increase in 2012 to stand at 40%. The return on capital employed shows the profitability of the company relative to the equity base and non-current liabilities so the higher the ratio the better and relays a healthy signal to the investors targeting long-term capital gains. It’s to note that during 2013’s AGM shareholders stressed out the fact that Apple wasn’t declaring cash dividends and criticized the company’s cash dividend payout policy.

This indeed in parallel to a decreasing stock price (-35%) at AGM date the company was forced to payout 2.65$/share (Gupta, 2013), whereas the shareholders disregarded couple of important facts highlighted below:

• The cash dividends payout would setback the company with the same amount; put simply the company lost the amount paid out instead of reinvesting it in R&D which is the core element in the industry.
• The shareholders are shortsighted, as when the company reinvests the profit generated throughout the fiscal year and enhances its financial standing the share prices would automatically increase resulting in a substantial capital gain throughout time.

From my point of view, the shareholders were forced to call for cash dividends as the company showed ailing business signs in 2012 with their product launches. The shareholders came to an agreement that the company is not wisely investing its excess cash reserves into improving their product lines. Given the above and the recent market data, Apple’s shares value is declining thus shareholders have no superiority compared to other shareholders in

different companies, thus they were forced to treat the company as other market players in claiming cash dividends.

Liquidity and Financial Structure

Accounts receivable stood at USD 10.9Bn representing an increase of 104% over 2011’s figure of USD 5.3Bn which is in line with the level of sales. The receivables to sales ratio stands at 7% in 2012, 5% in 2011, and 8% in 2010. There’s no direct relation evident between the increases in receivables and sales thus I cannot prove that the increase in receivables implying looser credit terms to gain more sales stands out. The company’s receivables are mainly due to cellular networks in various regions which eliminates the receivables default risk as cellular networks do enjoy solid cash-flows.

The customer concentration risk is negligible as two customers out of the total portfolio make up 24% otherwise the remaining makes up a lower percentage out of the total receivables portfolio. This in fact is associated with a considerably low receivables turnover of 25 days in 2012 compared to 18 days in 2011 and 29 days in 2010. This indeed proves a healthy net operating cycle for the company as it recorded a positive gap of 60 days, thus the company receives its cash in 27 days split up into 25 days in receivables turnover and 2 days in inventory turnover whereas its payables turnover stands at 87 days which creates a favorable gap of 60 days in its cash cycle; this indeed justifies the firm’s nil bank borrowings and liabilities to bridge such gap.

The company’s accounts payable increased by 45% to stand at USD 21.1Bn compared to

USD 14.6Bn in 2011, the company is deferring the payables in order to ease its cash-flow to service short-term obligations. The increase in receivables warrants the parallel increase in payables in order not to cut down the favorable gap the company enjoys (Inc., 2012). In terms of equity the company enjoys a solid equity base with the accumulation of profits under retained earnings.

The equity base is made up mainly of retained earnings whereas the common stocks made up 14% of the footer. The stock’s dividend payout ratio in 2012 (as previous years the company didn’t declare cash dividends) recorded 11%. The dividend yield of Apple recorded an approximate 1.81% compared to a 2.42% of Microsoft on an annual basis, which is considered to be below industry norms (Austin, 2012). In comparing Apple’s stock to its competitors its worth mentioning the following:

• Apple recorded a drop of 32% in its stock price in comparison to a 13.60% increase on the SP500 index.
• On the 3-year stock price growth, Apple is still leading by far from the benchmark given its successful product mix and value proposition; whereas last year’s product innovation came in below par compared to its competitors reflecting the beginning of decline stage due to its obsolete product mix being sold.
• Apple’s stock was trading below the SP500 index for the past year, which led investors to demand cash dividends to mitigate the value depreciation of the stock.

Key Financial Ratios/ Indicators

 Short-term Liquidity Current ratio recorded 1.5 times in 2012 compared to 2.01times in 2010, which is due to the fact that current assets

and current liabilities increased in parallel in 2012 relative to 2011 figures. This ratio reflects the company’s abilities to meet its short-term obligations. On the other hand the acid test ratio recorded 1.48 times compared to 1.96 times in 2010 whereas this is due to the fact that the company’s inventory is kept at minimal levels (safety stocks) whereas the remaining production batches are usually pre-booked given the products’ popularity (Inc., 2012).

Solvency Ratios Debt to equity ratio (DER) recorded 0.49 times compared to 0.52 times in 2011 and 0.57 times in 2010 due to the fact that the company’s equity base increase was higher than the liabilities’ increase. This ratio reflects the company’s financial leverage in terms of reflecting the proportionate reliance of the company on liabilities and equity to fund its assets. On the other hand gearing ratio recorded 0.14 times (14%) in 2012 compared to 0.13 times (13%) in 2011, and 0.12 times (12%) in 2010 is considered to be healthy as it shows the level of long-term liabilities contribution to the long-term capital structure of the company (Inc., 2012).

Simulation Model

A simulation model has been constructed in order to study the variability of the cash flows of the company under several possible changes in the economic condition (Please refer to the attached spreadsheet). The underlying assumptions in this model are:

• The worse the economic condition, the faster the investors will demand to be paid in line with the industry benchmark ($3.5/share)
• Cost of goods sold is controllable to a certain extent, whereas in a market crash situation, the company is expected to
  

reduce 5% net to match its drop in sales

The model has generated a range of values of free cash flow for each of the economic condition assumed. As the economic condition gets worse, the risk in investing in the company increases and the free-cash flow decreases.

Recommendation

The mobile communication and media device market is a fast evolving market and competing companies must account for the products and services of one another. In the case of Apple, and as was mentioned earlier, their products are limited to the mobile communication and media devices. However, they have high product concentration that makes up most of their sales. Apple needs to rely on products that have been low in the market such as the iPod or the Mac computers. However, due to the high level of imitation and competitiveness, Apple needs to invest more in its research and development in order to avoid product saturation, which has been seen the case recently due to redundant technology.

Apple’s competitors posses a strong advantage over Apple in that they are able to target different customers and different customers. For example, Samsung not only produces mobile communication and media devices only, they are also well known for their home appliances such as televisions, fridges, etc. As for Apple, there is only one mobile phone: the iPhone and the other products are limited to either mobile communication or media devices only (as has been mentioned in section 2.1).

As a recommendation, Apple should work on expanding its target market in order to continue its competition.