Reassessing Apple's "AI Potential" - Comparing the AI Phone Upgrade Trend to the 5G Boom

Reassessing the value in the AI era, is it finally Apple's turn?

In the overnight US stock market, Apple's stock price saw a rare surge, closing up significantly by 4.3%, with a market value skyrocketing by 811.3 billion RMB overnight.

On the news front, the focus of the M4 chip will highlight AI capabilities. Morgan Stanley pointed out in yesterday's report that the market may reassess Apple's "AI potential".

Morgan Stanley has slightly adjusted Apple's year-end target price from $215 to $210, with a 20% upside potential from the current stock price. Based on the positive outlook for the AI-driven iPhone upgrade cycle and service revenue, Apple's stock is given an overweight rating.

Despite facing various headwinds currently, investor sentiment towards Apple is improving. Morgan Stanley noted:

Currently, Apple is facing challenges such as declining demand and deteriorating prospects for service revenue growth, including poor iPhone sales in the Chinese market, cancellation of car development, and downward risks in service revenue due to regulatory scrutiny in multiple regions. However, broader investor interest in its stock is increasing, especially among those investors who had previously avoided it due to higher valuations.

The attractiveness of Apple's investment is mainly attributed to two factors: a decrease in valuation premium and the AI-driven iPhone upgrade cycle.

• Moderate valuation premium: Apple's stock price has fallen by 13% since the beginning of the year, currently trading at 25 times next year's earnings, lower than the lower end of the trading valuation range after the release of the 5G phone (iPhone 12).

• AI-driven iPhone upgrade cycle: Investors are increasingly interested in the cyclical market brought about by AI-driven device upgrades, a trend based on the 5G upgrade cycle. This factor is particularly valued by long-term investors such as hedge funds.

Furthermore, looking at the similarities between the AI upgrade cycle and the 5G upgrade cycle, there may be three major similarities:

1. Hardware adoption may be ahead of consumers' understanding of specific application scenarios, driven more by expectations of strong application prospects, although doubts still exist regarding AI application scenarios.

2. Due to the upgrade cycle, the replacement cycle may temporarily accelerate within 2-3 years, then return to normal sales levels.

3. Lack of backward compatibility—5G capabilities cannot be activated on the previous generation 4G phones, and it is expected that AI functions will also not be supported on old phones.

It is worth mentioning that Morgan Stanley pointed out that, from the perspective of the 5G upgrade cycle, the valuation reassessment began one year before the release of 5G products (iPhone 12 in 2020), and similarly, the AI upgrade cycle will start with iPhone 17 (expected to be released in September 2025), with the valuation reassessment expected to arrive in 2024. Morgan Stanley expects specific financial outlook for Apple, with revenue expected to decline first and then rise. It is projected to decrease from $383.285 billion in 2023 to $375.988 billion in 2024, and then increase to $386.715 billion and $439.576 billion in 2025 and 2026 respectively. Profitability is expected to continue to strengthen, with adjusted EBIT and EBITDA expected to steadily increase from 2024 to 2026. In terms of net income and earnings per share, it is expected to grow year by year from $96.995 billion and $6.13 in 2023 to $119.355 billion and $8.30 in 2026.