Losing Its Grip on No. 1

Losing its grip on No. 1... Apple's new ventures... Apple is cheaper than it has been in 15 years... The U.S. doesn't need OPEC... It needs Canada... A 'permanent structural shift'...

Yesterday, iPhone maker Apple (AAPL) briefly lost its status as the world's largest publicly traded company to search-engine giant Alphabet (better known as Google). Although Apple shares rebounded to reclaim the top spot, the shift marked a break in Apple's roughly five-year run as No. 1.

In 2015, sales from Apple's iPhone smartphones, Mac computers, and iPad tablets totaled $204 billion, or 87% of the company's sales. The iPhone alone brought in $155 billion, or 66% of sales.

Last year, Apple sold 37% more iPhones than it did in 2014. All told, iPhone sales grew at an annual rate of 57% from 2008 to 2015.

But that pace is no longer sustainable. As we noted in the January 27 Digest...

Apple expects sales of just $50 billion to $53 billion in the first quarter of this year, compared with $58 billion last year. This would mark the first year-over-year decline in sales since 2003. It also expects iPhone sales to fall for the first time in history.

In an unusually downbeat conference call, CEO Tim Cook told analysts and investors that his company was "seeing extreme conditions unlike anything we've experienced before, just about everywhere we look."

Still, Apple has a huge market share. It controls 16% of global smartphone sales. That's second only to Samsung, which has around 23%, according to market-research firm International Data Corporation (IDC).

And keep in mind... Apple represents the high end of the smartphone market. People pay more for its products because of its quality and innovation. In many places, it's a status symbol.

Many analysts believe the current quarter is just the start of slowing sales growth going forward. But the growth potential in smartphones has shifted to developing markets like China and India.

And as Cook pointed out last year, the potential market for smartphones in these markets "is incredible."

Plus, the goodwill that Apple has with its customers gives it tremendous clout when it introduces new products, like Apple Pay and the Apple Watch. Plus, it continues to upgrade existing iPhone users to newer models.

But slowing iPhone sales means Apple needs to diversify beyond consumer electronics and into higher-end products, higher-margin content, software, and services.

The company rolled out the iPad Pro – which starts at $799 – in November. This week, IDC analyst Jitesh Ubrani called the iPad Pro "the clear winner" as the top-selling tablet in the previous quarter. The tablet market has several commercial uses, including the retail and medical markets.

IDC forecasted nearly 14 million shipments of the Apple Watch in 2015, which is nearly 60% of the total smartwatch market. Of course, the Apple Watch pairs with the iPhone, giving the company additional strong growth potential.

With Apple Pay – which we've discussed in previous Digests – Apple is trying to eliminate the traditional wallet altogether. The mobile-payment service is compatible with iPhones, iPads, and Apple Watches, and it digitizes and replaces the need for credit and debit cards. Apple collects a small fee for every transaction. If the services catches on, it's huge upside for Apple.

And while Apple may not have the same incredible growth potential it once did, those expectations are already factored into the share price.

Two of our favorite ways to value a company are the enterprise value to earnings before interest, taxes, depreciation, and amortization (or EV/EBITDA) and the enterprise value to free cash flow (or EV/FCF) ratios. EV/EBITDA looks at a company's market value compared with its earnings. EV/FCF looks at its market value compared with its free cash flow.

We consider an EV/EBITDA ratio of 10-12 times relatively cheap. Today, Apple trades at just 4.5 times EV/EBITDA. We consider an EV/FCF ratio of around 10 times to be cheap. Apple's EV/FCF ratio is just 6.3 times. By both measures, Apple is as cheap as it has been in the past 15 years.

New York University business professor Aswath Damodaran says investors should consider Apple a value stock today, like cigarette-maker Altria (MO). Even if Apple's business doesn't continue to rapidly grow, it can spend billions of dollars on dividends and share buybacks for several decades. And as Damodaran points out, iPhones are just as addictive as cigarettes.

And Apple has steadily grown its dividend around 8% annually, from $0.38 a share in August 2012 to $0.52 a share today.

Switching gears to the energy market...

The Saudis are powerless to push crude oil prices over the long term... and they know it.

In May 2008, the U.S. imported around 6 million barrels of oil and petroleum products per day from OPEC. Of that, 1.5 million barrels a day – or 25% – was from Saudi Arabia. Saudi exports to the U.S. have been declining ever since. As of November, U.S. oil imports were down to about 3.2 million barrels per day... only 1.2 million barrels of which were from Saudi Arabia.

Altogether, OPEC represents 35% of U.S. crude imports. Fourteen percent of these imports are from Saudi Arabia. Because of the U.S. shale-oil revolution we've written about countless times, that number is set to decline even further...

At $30 a barrel, shale oil is uneconomic. But that doesn't stop the boom. There's simply too much oil in the U.S. that's still profitable to produce at $12 a barrel.

Higher-quality companies continue to produce oil. And U.S. oil production is only 3% lower than its peak today, despite falling oil prices.

Many companies are continuing to produce oil at $30. These companies hope to outlast their weaker competitors while oil prices remain low. Then, the surviving companies will pick up assets for next to nothing... and the shale revolution will continue on.

The more important – and more reliable – trading partner for the U.S. is our neighbor to the north, Canada. Canada is responsible for 40% of U.S. oil imports today. And not only is the U.S. rapidly progressing to become more energy self-sufficient with Canada's help, but the two countries are set to become an energy export powerhouse.

As you can see from the following chart, minus Canada, the U.S. is importing less and less oil. Meanwhile, U.S. petroleum exports are on the rise... and set to increase further now that Congress has lifted the restrictions on crude-oil exports...

The Saudis would love to cut back production. But they can't. If they tried to, U.S. production would fill the gap. Beyond short-term manipulations, the Saudis truly are powerless.

Today, Saudi Arabia and Russia are pumping as much oil as they can – around 23 million barrels between the two of them, up more than 10 million since 2006.

These countries are attempting to make up for the loss of oil revenues by increasing production. They have to do that, because their political stability depends on it. And with Iranian oil coming back online as sanctions are lifted, the Saudis can't risk losing more market share.

Saudi Arabia and Russia depend on oil. They're going to pump as much as they can until the market stops them. That will continue to put downward pressure on oil prices.

Many folks think that energy prices will rebound in a year or two. But as Porter explained in the latest roundtable podcast, this is a permanent structural shift...

Many third-world economies are not going to be able to cope with a permanent loss of oil revenue. Venezuela, for instance, has $123 billion in foreign debt, $11 billion of which comes due this year. If oil prices don't recover, look for a sovereign default soon.

And that's just the tip of the iceberg... Saudi Arabia is running huge deficits and spending as if we'll see $100-a-barrel oil again soon. The International Monetary Fund estimates that Saudi Arabia may be running a deficit as high as $140 billion – or 15% of its GDP. Its financial reserves were down to $627 billion as of November. At that pace, it will burn through its reserves in less than five years.

But what's bad news for these energy regimes is good news for Americans. As Porter has told readers for months now, this will be the greatest legal transfer of wealth in history.

New 52-week highs (as of 2/2/16): Invesco Value Municipal Income Trust (IIM), Nuveen Municipal Value Fund (NUV), Public Storage (PSA), and short position in Santander Consumer USA (SC).

In the mailbag, more praise for contributing editor P.J. O'Rourke's latest piece. As always, send your e-mails – positive and negative – to feedback@stansberryresearch.com.

"Per PJ's article. I loved it. I'm not a 'Trump for President' person (more Ron Paul) but I do appreciate his appeal and the discussion he has provoked. Everyone else tiptoes around the issues. Not Donald. (But he is not too specific about his solutions...) I agree with PJ's assessment: Obama is self-serving and Barbara Bush for President! BTW, did you know Trump has his own line of eyeglasses and cases? The eye store gave me an extra case yesterday with 'Donald L Trump' embossed on the top and said some customers won't take it. It is well made. So I said what the hell. I have a Trump eyeglass case." – Paid-up subscriber Ann L.

Regards,

Bill McGilton
February 3, 2016