Brace for a bumpy 2022

Apple approached the all-time high of over $180 this week on more AR/VR hype. The surprise holiday success of the Meta Platforms Quest 2 device increased enthusiasm over the metaverse while Apple still remains up to a year away from launching their own device. My investment thesis remains increasing Bearish on the stock as investors pile into Apple at irrational valuations based on overhyped, unreleased products.

Metaverse hype
After Christmas Day, the Oculus Quest 2 app soared to the No. 1 overall app in the U.S. Even days later, the Oculus app still ranks high in the App Store with a No. 3 ranking in the Free Entertainment category and a No. 12 overall ranking.

Combined with Apple hiring the Meta Platforms communications and public relations head, the markets are full speed ahead on metaverse hype for the tech giant. The executive might have moved to Apple to lead the augmented reality products, but the company still isn’t expected to launch a device until the 2H of 2022. Big questions exist on whether the device will make the crucial holidays period and whether Apple can even compete with the lead built by Oculus.

Meta had reportedly already shipped 10 million units of the Oculus Quest 2 going into the holiday shopping season. Qualcomm tried to backpedal on those numbers, but the CEO isn’t going to state inaccurate third-party data.

A lot of these units would’ve been shipped in anticipation of strong holiday sales, but the holiday sales figure isn’t known yet. The product retails for $299 suggesting Meta has achieved ~$3 billion in sales now providing the company with a comprehensive VR platform and the impetus for changing the corporate name from Facebook to Meta Platforms.

Influential Apple analyst Katy Huberty previously predicted the company would sell 31 million devices at a price of $750 by FY26. In such a scenario, Apple would generate $29 billion in sales in 5 years from now. The company might top $400 billion in sales in a few years suggesting the hyped AR/VR product doesn’t even deliver 10% of annual revenues.

In essence, the excitement over the AR/VR device could cause Apple to rally. The big debate is whether such a move is logical considering this sales target requires the tech giant to sell the product for 150% above the base price of the Oculus device.

Apple analyst Ming-Chi Kuo has the mixed-reality device starting at $1,000 and selling ~3.0 million units in FY23 and 10 million units in what would amount to FY25. The second-generation product would be released in 2024 and revenues would hit anywhere from $3 billion to $10 billion in FY23 to FY25.

These amounts won’t move the needle at Apple and are very questionable considering the high price tags in comparison to Oculus devices already on the market.

CapEx questions
By the time Apple launches their AR/VR device, the tech giant will already face an entrenched sector leader spending $10 billion annually. Apple only spends $11 billion on capex making one wonder if the tech giant can sustain current profits while needing to invest aggressively in metaverse devices and autonomous vehicles.
Apple has historically spent limited amounts on capex in comparison to revenues. Over the last decade under the leadership of Tim Cook, the tech giant hasn’t boosted capex meaningfully with the TTM amount during COVID-19 shutdowns dipping down to the $8 billion level similar to a decade ago.

In fact, Apple only spends $11+ billion on capex while Meta Platforms just proposed losing $10+ billion on the metaverse alone. Alphabet, already spends $24 billion annually to invest in categories such as AV technology. Even Microsoft (MSFT) spends $24 billion on capex questioning how Apple can beat these very capable tech giants while spending what is quickly amounting to half of these other trillion-dollar companies.

Meta forecast spending an incredible capex range of $29 to $34 billion next year, up from just $19 billion in 2021. The company is trying to separate from Apple while Apple’s capex spending has been stagnating for a decade. Noteworthy, Apple was the leader in capex spending when the company was truly innovating with the iPhone and the iPad while Apple is probably only spending in the millions now on the AR/VR device.

The numbers support investor concerns that Apple has relied entirely on expanding existing products via maintenance capex on products such as the iPhone and Mac and transitioning to the Watch. The company has far under-invested in growth areas such as AVs and metaverse devices while the market expects irrational success despite these potentials under investments. These products require new technology, not enhancements and modifications of existing products.

Of course, Meta or Alphabet spending more doesn’t guarantee success. These companies could be throwing cash at inefficient processes or hiring unnecessary employees not providing the desired productivity before the market is ready for the products. At the same time, Apple would become possibly the first tech company to win new categories by investing far less.

Any announcement on ramped-up spending could launch an arms race reducing the profit growth of Apple. Analysts only forecast 5% annual EPS growth now through FY25 amounting to ~$0.30 per share boost to profits. The EPS target only grows from $5.71 in FY22 to $6.56 in FY25.

With 16.4 billion shares outstanding, the EPS growth amounts to ~$5 billion in additional profits per year. Apple probably needs to boost capex by a similar amount cutting most of the cash flow growth out of the current analyst forecasts.

After a decade of dropping additional gross profits to the bottom line due to flat spending on capex, Apple needs to start ramping up capex spending. The market might decide now isn’t the time to keep paying a premium valuation for the stock after not factoring in the need for the tech giant to seriously ramp up capex. A lot of these tech giants have avoided past arms races with most products not really crossing over with these other players.

Takeaway
The key investor takeaway is that Apple remains priced for perfection while the company faces a bumpy 2022. Analysts already forecasted limited revenue and EPS growth over the next few years due to COVID-19 and 5G wireless pull forwards while the company needs to invest more in new products to succeed.
As the stock rallies to a $3 trillion valuation, investors need to prepare for weakness in 2022. Any signs of the need to ramp up spending will further crunch any expectations for EPS growth through FY25 and hurt the stock. Seeking Alpha