Apple's Declining Capex
The most surprising revelation found in Apple’s recent 10-Q and 10-K filings is related to capital expenditures (capex). For the first time in 16 years, Apple expects its capex to decline during the current fiscal year. Declining capex is made that much more intriguing for Apple considering how Amazon, Alphabet, Microsoft, and Facebook are each experiencing significant increases in capex. Analyzing Apple’s capex and the potential reasons for its decline provides a look at how the company is being managed and how Apple is unique when compared to other Wall Street giants.
Defining Capex
Capex refers to cash a company spends on buying or upgrading long-term assets in order to improve cash flow, productivity, and ultimately, value. These expenditures include both tangible and intangible items.
As depicted in financial filings, Apple’s capex includes money spent on:
Product tooling and manufacturing process equipment.
Data centers.
Corporate facilities and infrastructure, including information systems hardware, software and enhancements.
Retail stores.
Additional capex items include acquiring intellectual property such as patents.
One way of distinguishing capex from regular operating costs (opex) is that capex benefits a company beyond the current fiscal year that the expense occurs. While opex are deducted as they are incurred, capex are one-time costs capitalized on the balance sheet with the expense spread across the lifespan of the asset. Cash spent on assets that have not been proven commercially viable fall under R&D and is expensed as incurred.
Apple Capex: By the Numbers
At the end of each fiscal year, Apple provides an expectation for the amount of capex that it will report during the upcoming year. As shown in Exhibit 1, for the first time in 16 years, Apple expects a year-over-year decline capex in FY2019. Apple’s initial expectation called for $14B of capex in 2019, down from the $16B of capex originally expected in 2018.
Exhibit 1: Apple’s Initial Expectations for Capex (Annual)
For a variety of reasons, including the difficulty associated with estimating capex, Apple’s final capex total will often differ from its initial expectations. Exhibit 2 includes Apple’s final capex reported at the end of each fiscal year. Excluding how capex came in above Apple’s initial expectations in FY2018, the trend had been for capex to come in less than initial expectations. This is why it wasn’t too surprising to see in Apple’s most recent 10-Q that management had reduced its capex expectations for 2019 even further. Apple now expects $12B of capex in 2019. Based on this revised estimate, Apple may end up reporting a nearly 30% year-over-year decline in capex.
Exhibit 2: Apple’s Reported Capex (Annual)
The amount of cash Apple spends on capex during any given fiscal year will likely differ from reported totals. Companies disclose the amount of cash spent on capex via the cash flow statement using the line item property, plant, and equipment (PP&E). Exhibit 3 reflects the amount of cash Apple spent on PP&E over the past 10 years. It is not unprecedented for Apple to report a modest year-over-year decline in PP&E. However, this doesn’t take anything away from Apple expecting a rare drop in reported capex in 2019.
Exhibit 3: Apple Payments for Property, Plant, and Equipment (PP&E)
Theories
What may be behind Apple’s expectation for capex to decline by nearly 30% in FY2019? There are a number of plausible theories.
Apple is buying less tooling and manufacturing machinery. In the late 1990s, Apple began outsourcing product manufacturing to third-party contract manufacturers. The move was done in an attempt to improve the company’s balance sheet and create a leaner, nimbler, supply chain. Given Apple’s reliance on contract manufacturers, the company doesn’t own a complex web of factories around the world. However, Apple does own much of the specialized tooling and machinery found in these factories.
Apple cut back the pace of retail store openings. Apple may be spending less on its brick-and-mortar retail apparatus. After an aggressive store opening strategy in China, Apple cut back on its retail footprint expansion and instead has been focusing on opening fewer, more high-profile stores.
Capex headwind from elevated spend on facilities is winding down. The decline in capex may be due to Apple having already spent aggressively on various capital investments including new data centers, land purchases, and a new $5B headquarters.
Apple’s initial expectations will end up being proven wrong. It is possible that Apple’s expectation that capex will decline in 2019 may simply end up proving conservative.
While there may be some logic found with each of the preceding theories, a few theories end up having more holes than others. Consider the following:
Retail store remodels. The declining number of store openings ignore what has been a substantial amount of resources being dedicated to store remodels around the world.
Lower expectations. After three months, management has already lowered its 2019 capex expectations from $14B to $12B. It is not likely that Apple is simply running with conservative capex expectations and will somehow end up reporting more than the $16.7B of capex in FY2018.
Most Logical Explanation
When taking the preceding theories into consideration, two stand out as being the most logical. As shown in Exhibit 4, despite the surge in wearables sales, the overall number of devices manufactured has remained roughly the same due to the decline in iPhone sales. This would suggest no major growth in capex due to additional tooling and machinery. In addition, Apple is coming off of a massive investment cycle for iPhone related to OLED and Face ID. Management was not exaggerating when saying the iPhone X marked a turning point for the iPhone business. This dynamic likely resulted in elevated capex in recent years which is now cooling down a bit in 2019.
At the same time, Apple management’s capex expectation for 2019 likely reflects little growth in tooling and manufacturing machinery related to a major new product category. Apple’s fiscal year ends in September, and the latest rumors claim that high volume production for Apple Glasses will be more of a FY2020 event.
Exhibit 4: Apple Device Unit Sales
Note: "Other" includes Apple Pencil, Apple TV, HomePod, and select Beats headphones. Wearables include Apple Watch, AirPods, and select Beats headphones.
Another contributing factor behind declining capex is that Apple likely finds itself facing less of a capex headwind from years of significant growth in infrastructure. As disclosed in Apple’s most recent 10-K, the company had amassed a significant amount of office space and land in recent years. As of September 29th, 2018, Apple owned 16.5M square feet and leased 24.3M square feet of building space, up 12% from the previous year. In addition, Apple acquired 2,448 acres of land in 2018 to have a total of 7,376 owned primarily in the U.S. As Apple grows into its expanded footprint, the company is likely taking a temporary breather in terms of capex on corporate facilities.
Peers
Apple’s declining capex highlights the remarkable capex shift among the Wall Street giants (Microsoft, Apple, Amazon, Alphabet, and Facebook). Exhibit 5 highlights the change in PP&E from FY2016 to FY2018 for the five giants. In 2016, Apple led the pack with nearly $13B of PP&E. The closest peer was Alphabet at $10B. Jump ahead two years, and the landscape has completely changed.
Exhibit 5: Payments for Property, Plant, and Equipment (PP&E)
Alphabet spent $25B on PP&E in 2018, nearly double the second-highest total reported by Facebook ($14B). Based on Apple management’s capex expectation, it is likely that Apple will also be surpassed by Microsoft and Amazon when it comes to PP&E in 2019. This means that in just two years, Apple would have gone from being the highest to lowest spender in terms of PP&E.
On a combined basis, the $32B increase in PP&E reported by Alphabet, Facebook, Amazon, and Microsoft between 2016 and 2018 exceeded Apple’s PP&E growth by 56x.
Change in PP&E (2016 to 2018)
Alphabet: $15B
Facebook: $9B
Amazon: $5B
Microsoft: $3B
Apple: $1B (rounded up)
Business Models
Business models dependent on collecting as much of our data as possible require increasing investment at unprecedented rates. This would explain the massive increases in PP&E reported by Alphabet (Google) and Facebook. Each is a services company focused on offering free, data-capturing services to as many people as possible. The business models are dependent on achieving scale in order to grab as much data as possible.
Amazon is a retail platform company focused on getting you to buy and consume more products over time. Scale in terms of purchase volume is needed in order for the cash flow/reinvestment cycle to continue. Amazon’s data capturing investments are a bit more difficult to observe via PP&E growth given the company’s need to make other long-term investments to support its cloud business.
Apple is a design company focused on selling tools capable of fostering premium experiences. Instead of chasing scale with the goal of monetizing data or usage, Apple sells tools that management thinks people will want and are willing to pay for. For Apple, scale is considered a byproduct of a properly functioning business model.
Declining capex in any given year does not necessarily reflect Apple management underinvesting in its business. Instead, as discussed above, such declines result from Apple leveraging its existing fixed assets to generate robust free cash flow. In essence, Apple’s business model is capex light.
Ultimately, Apple's business model predisposes the company to superior free cash flow generation. The company is capable of monetizing premium experiences much more effectively and efficiently than anyone else. Free cash flow is a measure of how much cash is generated after taking into account capex and other costs associated with running the business. Apple's $62B of trailing twelve month free cash flow is $6B more than the combined free cash flow produced by Alphabet, Facebook, and Amazon during the same time period. Given how those data capturing companies find themselves needing to spend increasing amounts on capex, Apple will likely be able to maintain its significant free cash flow advantage for the foreseeable future.
Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.