Apple Pay is Catching On – Catalyst for P/E Expansion

Apple (Nasdaq: AAPL) announced last Tuesday that the list of companies working with Apple Pay has expanded to now cover a significant portion of the nation’s transaction volume. While it still has a ways to go to completely reach every possible transaction at every store, reports indicate that it is being adopted at a fast pace. In my opinion, Apple Pay is the main reason why Apple’s shares have recently run higher, and for good reason. I expect the business to make an important contribution to the company’s growing operational results. I also believe it is allowing the previously stale P/E ratio some room to grow, which means Apple shareholders are in for some special gains in the next few years.

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Apple Pay just added several more financial institutions to its list of payments partners, including SunTrust Banks (NYSE: STI) and others, according to one of my resources for this report. From the consumer perspective, Apple Pay now supports 90% of all potential credit card transactions in the United States. The company is also seeking arrangements with providers of debit cards, prepaid cards, co-branded cards, small business credit and debit cards and corporate cards.

Apple (Nasdaq: AAPL) must also win the support of retailers and all companies that accept payments for goods and services. Early signees include McDonald’s (NYSE: MCD) and Whole Foods Market (Nasdaq: WFM) and recent signees include Staples (Nasdaq: SPLS) and others. Given the degree of Apple iPhone penetration, it behooves retailers and restaurants to accept Apple Pay in order to best serve customers. So this is something retailers are likely asking Apple about in many instances before Apple even approaches them.

Not only is the service becoming available though; it is being used by Americans. McDonalds indicated that 50% of its tap-to-pay transactions were through Apple Pay in November. It is being adopted because it simplifies the transaction process for customers and is a value-add for Apple’s partners. According to the New York Times, the NBA’s Orlando Magic basketball franchise expects it to speed service at its concession stands. Since lines at ballparks and stadiums are limiting to sales, as many fans hate missing the action, if Apple Pay can speed transactions it will help these partners sell more food and beverages and other goods. That is a value-add to sales and earnings, and all the more reason for companies to partner with Apple on this.

In the past, similar services provided by Google (Nasdaq: GOOGL) and others have failed where Apple seems to be succeeding. I think that is because of Apple’s broad iPhone penetration; big PR voice that got the message across clearly to a broad swath of America when it introduced the service; and because of today’s tech savvy population, which has gotten much better at picking up new technology. People want to try it out and are willing to spend some time to learn how to use it.

Some retailers are making their own app, including a consortium headed up by Wal-Mart (NYSE: WMT), but I’m not sure people are going to want to join up for more than one payment app. I suppose the consortium may be able to better compete with Google’s Android platform, but Google (Nasdaq: GOOGL) is likely stepping up its game to help support its platform partners.

While Apple has not offered much information on how successful Apple Pay has been, its partners have been talking. On CNBC Tuesday, I watched a SunTrust representative as he said the service was showing good progress. Obviously, as a newly won business partner, this SunTrust representative was supplied with the figures we have not yet seen. We do know that over 1 million cards were registered with Apple Pay within the first 72 hours of operation, according to Tim Cook.

But there is also circumstantial evidence. This weekend (12-20-14), I saw evidence that banks are using Apple Pay as a draw for their businesses, with commercials for Bank of America (NYSE: BAC) and J.P. Morgan Chase (NYSE: JPM) both flashing partnerships with Apple Pay. They would not be doing this if they did not see strong penetration and consumer interest in the application. Basically, the banks are riding the coattails of the highly popular Apple brand and its newest and greatest thing.

Over the last few years, I’ve often proposed that Apple’s low PEG ratio was reflecting investor concern that Apple could not keep growing and might even see some erosion of market share. We have been looking for the company to expand its efforts into television sets and other gear, and it has entered the wearables market with its Apple Watch. But I think it is Apple Pay that is most exciting investors today, and the reason for the stock’s gains since its introduction.

1-Year Chartof AAPL at Seeking Alpha

Apple’s P/E ratio is now 13.8X the analysts’ consensus EPS estimate for FY 15 (Sep). The company’s valuation metrics have been expanding, but the forward P/E ratio here still shows room for further expansion in my opinion. I expect that as the data is reported and investors begin to better see the potential for Apple Pay and Apple Watch, the P/E and PEG ratios will expand further. Given analysts’ expectations for 20% growth in FY 15, the current PEG on these figures is 0.7x. That’s cheap. Looking at the long-term growth estimate, I expect it will be revised upward from the current 11.5% estimate once data for Apple Pay and Apple Watch start rolling in. But even so, the company’s PEG ratio using this figure is a still modest 1.2X, and fails to incorporate the dividend yield Apple offers of 1.7% today. Reiterating and concluding, as data comes in and estimates are revised, I expect we’ll also see P/E expansion, so shareholders of AAPL will get extra lift to their investment return. Thus, I still love AAPL here. I cover AAPL semi-regularly, so readers may want to follow my blog and my column at SA.

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