RBC’s autocallable digital plus barrier notes tied to Apple offer bet on earnings, low entry

By Emma Trincal

New York, Jan. 28 – Advisers tend to avoid gambling but for Apple bulls, a deal pricing on Tuesday may be worth the thrill.

Royal Bank of Canada plans to price 0% autocallable digital plus barrier notes due Feb. 3, 2021 linked to the common stock of Apple Inc., according to an FWP filing with the Securities and Exchange Commission.

The deal will price at the close prior to the company’s announcing its first-quarter earnings at 4.30 p.m. ET.

The share price of Apple, which closed at $156.30 on Monday, is down by a third from its Oct. 3 high of $233.47.

The bear trend was triggered by Apple’s previous earnings on Nov. 1 after the company issued disappointing guidance and lower iPhone sales, pushing the stock below its $1 trillion market cap. Another big factor was the company’s announcement that it will no longer report iPhone sales numbers.

The structure of the notes shows one annual call with a 16% premium if after one year (Jan. 29, 2020) the stock closes at or above its initial level. There are no contingent coupons.

If the notes are not called and the final level of the stock is greater than or equal to its initial level, the payout at maturity will par plus the greater of 20% and the return, with the payout capped at par plus 40%.

If the stock declines by up to 20%, investors will receive par.

If the stock declines by more than 20%, then investors will receive a number of shares equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

Mad money

“I would probably roll the dice with it,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“When it comes to Apple, you have to separate Apple’s profits and business model here in the U.S., Apple’s profits and business model in the rest of the world and Apple’s profit and business model in China.”

“The stock is down 30% since November. But they didn’t report a loss. It was just below consensus. They gave guidance that their sales in China would be below expectations. Well Apple and just everybody else is going to be challenged by China.”

The adviser declined to guess the outcome of Tuesday’s announcement. But this time, analysts’ expectations are much lower, he noted, which may help the stock or at the very least reduce its volatility.

Strong company

Kunhardt said he is bullish on Apple long-term. He would not mind risking being long the stock as he believes in the fundamentals of the tech behemoth.

“Over the past couple of years, they refreshed their entire line of products, from the iMac, to the iPad, from the Mac Air to the iPhone,” he added.

Kunhardt sees current volatility around the tech giant as an opportunity.

“The valuation is great. Now is the time to buy,” he said.

The highest “risk” with this note is to see one’s return capped at 40% in two years.

“You call it a risk. I call it greed,” he said.

The 80% barrier at maturity offered sufficient protection in his view.

“I really don’t see Apple being below its current price two years from now or even one year from now. Even if we have a bear market. They’re still going to sell phones, they’re still going to sell tablets. Besides, they no longer just do hardware. Their main business line now is services. It’s the cloud; it’s iTunes; it’s Apple store. They’re everywhere.”

Three possibilities

Kunhardt anticipates three possible outcomes for the structured note investor.

In the first one, the company reports results that meet Wall Street’s consensus. The stock will not move, he predicted.

“In that case, the announcement is a moot point. But you’re already 33% down from the high. To think that you’re not going to be ahead in two years is unreasonable,” he said.

In the second assumption, the guidance and the results are positive.

“The stock spikes and you’re off to the races. You may already be up 20%.”

Having purchased the stock ahead of earnings, investors would just add another margin of safety, he said.

“It’s pretty obvious to me that at the end of the year, you’ll get called with 16% unless things collapse. So, you’re taking home 16%. What’s wrong with that? The stock could be up more, much more. People can be greedy. I realize that. But come on...be happy with it!”

The third and worst scenario would be a repeat of last quarter.

“It’s a miss and the stock plunges again. OK, you may not get your 16% after one year. But you still bought the shares at a discount. From a valuation standpoint, it’s hard to imagine that Apple will be worth less in two years than today. It’s possible. But it’s unlikely,” he said.

Greed is bad

Based on his upbeat view on the stock, Kunhardt concluded that investors were likely to earn a double-digit annualized return within a one- or two-year period.

“If this is not enough for you, you have a problem,” he said.

“If you tell me, ‘Oh! I only got 20% a year,’ it’s like you go to the store and you don’t find the color of lipstick you want. In my book, it’s a First World problem to have. You still have a roof over your head; you have food; you’re still warm.”

Kunhardt saw little chance to breach the barrier regardless of the volatility around earnings.

“The higher risk is you get capped out on a stock like Apple.”

A gamble

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, held the opposite view.

“This is a non-starter for us. It’s a little bit of Las Vegas and in fact it’s a compounded Las Vegas gamble,” he said.

“First Las Vegas play: we don’t own individual stocks for our clients. We’re not in the business of picking stocks.

“Secondly: it’s a bet on the earnings. They’re going to report after the Bell and you’re buying ahead of that.

“You don’t have knowledge of the direction of the stock because you’re trading it before the information comes out.”

The 80% barrier did not provide enough protection, he said.

“It’s nice to have a 20% protection but it’s a barrier. A stock like Apple can be wiped out very easily and quickly. In less than four months, they lost a third of their value. Obviously, it’s not enough for an individual stock,” he said.

Never say never

Foldes’ reasoning would apply to any stock regardless of the soundness of its fundamentals or the reputation of the brand.

“There is no such thing as a solid stock. Fashions around brands come and go. Remember the hype of Polaroids in the 1970s? Not to mention Blackberry before the iPhone?

“The idea that something – a brand, a company – is very solid can be the source of serious misjudgments. I’m not casting any aspersion upon Apple. It’s a very fine company. But you just don’t know.”

RBC Capital Markets, LLC is the agent.

The notes will price on Jan. 29.

The Cusip number is 78013GHK4.

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