Apple: Cost Cutting Can Significantly Boost Market Cap (Rating Upgrade)

Summary:

• Apple is not longer a growth company, as sales are projected to increase at around 7% annually over the coming years.
• But the prospects of cutting SG&A and R&D expenses to levels seen in previous years has the potential to boost the company’s bottom line by over 10% a year.
• This factor is the main reason why I have a bullish stance on the company’s long term prospects, and I am long on Apple stock.

Apple (NASDAQ:AAPL) has been one of the most successful brands in history. After the launch of the first iPhone back during the global recession of 2008, its sales, profits and share price has skyrocketed and it isn’t showing signs of stopping.

While the tech behemoth remains one of the top selling brands in the world, it’s quite evident to me that since their aforementioned 2007 release of the original iPhone, they haven’t made many original advancements in their various products – smartphones, laptops, smartwatches or any other services.

While I do believe they tend to make superior products to other companies in the spaces they operate in (disclaimer: I’m an avid Apple product user), it begs the question if they really needs to be spending so much on R&D (research & development) to remain a top selling global brand.

With over $25 billion a year each in both R&D spending and SG&A expenses, without much original advancements to show for it, cutting a decent portion of that spending can yield a significant boost to the company’s bottom line and provide for further upside.

Let’s take a little dive.

Following Up: What Changes From Last Time

I wrote about Apple here on Seeking Alpha back at the end of 2022, where I talked about the results of the company’s decision to shift a significant portion of its cash away from investments and into share buybacks and other shareholder value programs.

The result of that, as I talk about towards the end of the article as a negative catalyst for the company’s margins, is that the company is potentially going to face a steep interest expense in the coming few years as a result of a higher debt load, higher interest expense, and lower overall interest income from investing their mountains of cash.

While I tended to focus on the negative catalyst as a major driver, there were some questions in the back of my mind about whether the company will ultimately shift into cost cutting measures and what they’d look like. Since then, Apple CEO Tim Cook has reiterated that they are not going to move forward with layoffs or other cuts to operating expense but rather focus on increasing R&D funding, something which I now am bringing into question.

So let’s see where that stands.

Apple Product Advancements Controversy

It’s not actually all that controversial to say that Apple hasn’t really done much original innovation over the past decade. If you follow the timeline of their product updates, you’ll notice that the features they release tend to have come out a few months earlier by rival brands.

Smartphone Products

While Apple has made impressive advancements to its phone camera, allowing users to make professional-grade photographs, nearly all their advancements have been seen in Samsung (OTCPK:SSNLF) and other products, which are generally released a few months before the Apple product update event.

Whether it’s switching around various jacks on the phone, introducing new features like health tracking and interface upgrades, there isn’t really anything in the iPhone that other companies have not already come out with.

Again, this isn’t to say that iPhones (subjective, I know) don’t have better performance features than Android (GOOG) (GOOGL) operating systems and it is evident that their operations are smoother and their product lifespan tends to be longer than rivals.

Even so, it’s not clear why there needs to be such a high level of spending to simply see where the industry is heading and what other companies are thinking of doing and adopting their operating systems and hardware.

Laptop Products

Again, while I believe that Apple computers are unparalleled when it comes to operating system smoothness and performance, there hasn’t been a worthwhile upgrade to their systems and certainly nothing better than competitors from Microsoft (MSFT) and Chrome (an Alphabet system) have.

While updating systems here does cost money, most of it is due to integration of their operating systems across other devices. This means that the company can certainly do the same by upgrading their laptop and PC systems with far less than they currently spend.

Smartwatch Products

The company did start off strong and released a superior product to others in the field, but companies like Samsung and others in the field have quickly caught up and since then, there hasn’t been many advancements.

Again, a good portion of the attraction to Apple products is the ease of which they are integrated with other products, which makes it much easier for some business and students to work across their products. Beyond some health related advancement with the Apple Watch, there hasn’t been anything worth writing home about if you aren’t already an Apple product user.

Other Products And Services

The other 2 products and services I gravitate to in this segments are the AirPods and streaming service. In both instances we again come back to Apple either releasing a slightly superior product to others existing on the market and in the streaming case – simply throwing some cash at stars to come to their platform instead of others like Netflix (NFLX) or Disney (DIS).

R&D, Operating Expenses Called Into Question

With all that being said, one of the main features of Tim Cook as CEO was that he approached cost cutting without actually cutting costs where it matters most, but rather opted for things like travel reductions and actually boosting R&D expenses to increase the rate of ‘advancement’ releases.

However, these new advancements and products again simply seem to mimic existing products like their new Vision Pro vs the Oculus (META) products and new updates to their MacBook and iPhone which already exist in other brands.

Here’s what I call into question:

Apple increased revenues by 72% over the last 5 years, from $229 billion to $394 billion (full year 2017 to full year 2022). Over that same time period, while their SG&A (selling, general & administrative) expenses increased by just 65%, from $15.3 billion to $25.1 billion, their R&D costs increased by nearly 150%, from $11.6 billion to $26.2 billion.

This brings their overall operating expenses up over 100% over past 5 years.

Margins Have An Uphill Battle

When it comes to the company margins, there are a few things I’m looking at from a negative standpoint for the company’s long term, which cost cutting can help mitigate and overcome.

The first if the company’s interest expense. The company has been using their cash piles to (mostly) buy back their own shares, which does well for the value of the company but it also depleted the company’s investment reserves, which generated billions of dollars each year in cash.

Now, the company has reported its first even net interest expense of around $106 million for full year 2022. While this number is laughable in the grand scheme of just shy of $100 billion in profits each year, it’s a trend I don’t want to see continue. That’s because as the company reported roughly $1 billion interest expense last quarter, an increase in that figure while interest income continued to decline can cost them a few billion a year down the line.

The second is their gross margins. The company has been able to increase their profits mostly off of product price increases, with the new iPhone costing over $1,000 a pop and other products continuing to see price increases.

While this bodes well in the short term, there’s a limit to how much the company can keep jacking up prices without people taking a beat. We already saw this in the past when they released the lower-priced SE version of their iPhone, which played well and created a lower revenue-per-iPhone figure.

I fully expect the company to report a gross profit margins under 40% over the coming years, which is down from over 43% in the last few quarters.

Cost Cutting Can Boost Those Margins

I’m not going to make a concrete guess on what these cuts can look like. But to me it’s quite clear that the company can reduce their R&D and overall operating expenses by a significant amount and still remain one of the top selling brands in the world.

While they may not need it and are taking a good way forward by not laying off a bunch of people and closing down underperforming departments, it’s almost inevitable in this day and age that they eventually will.

The way we’ve seen companies like Amazon (AMZN), Alphabet and others lay off quite a bit of people and end up with nearly identical results to their operations is something I’m near certain Apple is going to do at some point.

That being said, starting off with a 20% cut of the aforementioned operating expense figures can generate a near $10 billion boost to the bottom line.

In the past, the company was spending the equivalent of roughly 2.5% of revenues on research & development, which has since ticked up to around 7%. SG&A expenses, on the other hand, remain relatively stable at around 6%.

With revenues of around $400 billion, a reduction in R&D expenses from 7% to 4% results in an overall boost of more than $10 billion to the company’s bottom line, and I don’t believe that reduction will result in lower revenues.

Conclusion: The Potential Is Real, And I Believe It Justifies A Long Term Investment

While the company makes a lot of money, it’s quite obviously no longer a growth company – analysts currently project that Apple will report an averaged sales growth rate of under 7% over the next 3 years, with profits growing at just a slightly faster rate on behalf of price increases.

With that being said, Apple may no longer be such a great investment with a projected growth rate roughly in-line with the broader market. But if we take into account the company’s ability to boost their profits by about $10 billion a year, however long down the line that may come, that changes the picture.

Given that I believe that a $10 billion boost to the company’s bottom line, due to these operating expense decreases is a very likely occurrence within the next few years, I think Apple represents a solid long term investment.

I am bullish on Apple’s long term prospects.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AAPL, AMZN, DIS, NFLX, SHORT META either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Opinion, not investment advice.

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