When you're the big dog, everyone wants to see the latest trick you can pull. For Apple, though, its recent performance left the audience a bit wanting. In an earnings report that hit expectations on revenue ($52.9B consensus, $52.95B actual) and beat them on earnings ($2.10 per share, 4% above the $2.02 forecast), Apple found itself slipping by 2% in after hours trading after hitting an all-time high yesterday.
Special sauce? Apple's much-criticized Macbook Pro helped propel revenues for the company up nearly... [+]
Why? iPhone sales came in a touch under the forecast and CEO Tim Cook suggested to analysts that people may be delaying purchases of Apple's iconic smartphone because they've heard an unusual amount about the new one. Altogether, it was another quarter in which Apple's "good enough" wasn't scintillating and that could mean a near-term pause in the rise of its shares.
Before diving in, though, a couple of important disclaimers. First, I use the estimates from the estimable Philip Elmer-DeWitt at his Apple 3.0 site. Philip compiles Wall Street pros and amateurs right before earnings, the best time to understand what's expected of Apple. I used only his pro consensus to compare Apple against. Second, the framing of this series is the battle between tech giants to achieve the first $1 trillion-dollar market cap. In itself, that's just a number and shouldn't be overestimated in import. But it's also been a barrier, like the 4-minute mile and the sound barrier that has felt impenetrable. These posts will obsess less about the market cap, per se, than about the continued growth of the companies in creating value through growth and outsize profits.
What's to like?
In a quarter where iPhone shipments actually declined -- 51.2 million last year, 50.8M this year -- Apple saw its revenues rise. No, the 4.5% bump in top line isn't breathtaking, but it's important to a company that's increasingly been reliant on the iPhone for years now. One particular bright spot was the much maligned Apple Watch. It's worst quarter (likely by far) came this period last year when sales were estimated at just over 1 1/2 million by analysts. Apple says they more than doubled this year and while the company doesn't break out figures, the consensus among smart folks is that puts the quarter over 3 million.
That puts the 2-year total for Apple Watch at greater than 25 million sold. Cook said Apple's wearables business was well into the Fortune 500 if measured as a standalone ($5B+). That grouping, which includes Apple's AirPods and the various Beats headphones, is still smallish compared to Apple's $233B in revenues last fiscal year. But it's growing nicely and helped boost Apple's "Other Products" segment by 31%.
Anecdotally, the Watch seems to be turning up on more wrists too. There were at least 10 on my recent flight from Seattle to London and while that's just a small sample the data above suggests mid-single-digit penetration among the iPhone population is here or nearly so.
The other shining light remains services, which ticked over $7B for the second-straight quarter. That represents an 18% rise year over year and puts Apple within its goal of reaching Fortune 100 levels this year with that category alone (don't be shocked to see it reach Fortune 90 levels). App Store, Apple Music, and the nascent subscriptions business all contributed to what had been Apple's fastest-growing revenue line. That it didn't slow down -- and yet got beat on growth by "others" -- is strong for the company.
Lastly, it's worth noting that Mac shipments rose 4% despite constant tech-press haranguing about the Mac. Revenue was up a much stronger 14% as the new Macbook Pro continues to defy skeptics by doing well in the market. With long overdue iMacs coming later this year and a commitment to renew the Mac Pro when it's ready, Apple seems poised to see continued gains in Mac sales even as the overall PC market continues to shrink. (Microsoft's Surface, by contrast, plummeted 26% in the most recent quarter.)
What's not to like?
Let's start with iPhone, which slipped 1% in units and eked out 1% revenue growth thanks to a continued move toward the larger-screen iPhone 7 Plus. Cook sent up a red flag that buyers might be delaying purchases to wait for the iPhone 8. He didn't call it the iPhone 8, didn't promise it would ship in September (some reports this week suggested delays -- I'm skeptical), didn't promise it would be amazing. But whatever it's name, the new OLED model with thinner bezels, a bigger screen in a smaller body, and very likely a TouchID embedded in the screen is coming. It's also expected to be pricey and likely to impress the Apple faithful, even if the blogosphere yawns.
If buyers are already sitting on the sidelines, the next six months could be rough for Apple. The coming quarter is always slow but if even 5% of whatever demand might be there otherwise is shifted, that's more a billion dollars in revenue Apple might have to cool it heels waiting for. This is, again, less of a long-term problem and more the kind of thing that could buffet the stock price into summer.
The next big problem remains iPad, which bled another low double digits in revenues (down 12%) and units (-13%). Apple seemed to make its clearest statement yet that the Mini is the real drag on those sales. CFO Luca Maestri said that large iPads grew globally over last year. Mini is between a rock and a hard place: Apple is non-competitive on price with low-end tablets from Amazon and Samsung and its larger-screen models essentially dominate, making it hard to find growth there.
It can't seem to find its way to lower the price of Mini to, say, $199 and instead actually discontinued the cheapest Mini when it brought out the latest $329 iPad model. This seems like a strategic error to continue ceding a market segment to competitors when Apple could afford to use the Mini as a low-margin entry product the way it once used iPod Touch. More on this in a future post.
What's making it hard for Apple?
As most know, market cap is a function of share prices times shares outstanding. Apple keeps buying its own shares back and retiring them, which reduces one of those two multipliers even as rising share prices increase the other. In terms of growing market cap, Apple's capital return program is something of a leaky bucket. Consider that yesterday the company increased the total program to $300B of which $210B is for buybacks. Additionally, the company noted that $151B has been spent on its own shares to date leaving $60B authorized to buy more.
Now, let's consider what happens if Apple spends that all tomorrow at the open (leave aside that this is impossible to do). Apple could take out 41.4M of its shares with a fully realized repurchase. That would take 0.8% away from the share count and require a slightly larger percentage rise in the share price just to break even on market cap. Of course, it's possible Apple will be rewarded for doing the buyback with higher share prices. But consider that back in February 2015 when the market cap hit $775B the share price was right around $130. Using the after hours quote, Apple is at a nearly identical market cap even with shares trading more than 10% higher. (The share count is down more than 12% since the program began.)
This isn't an indictment of the buyback and it's critical to mention Apple has paid an ever-larger dividend over that time too. In fact, it just raised the per-share payout 10.5% to 63 cents per share. Even if the market cap falls or stays flat, shareholders win from Apple's continued philosophy as outlined by Maestri of returning all free cash flow to them. Apple can afford this largesse not because it has $256.8B in cash as many report, but rather because net cash less debt outstanding remains at $158B. Apple has kept that truer representation of its liquidity essentially flat for the 2+ years of buying its stock.
Where to from here?
The short term dip after hours may translate into some malaise in Apple shares or they may continue the strong rise of late if markets remain robust. But either way, Apple's ability to gain 30% more market cap from here is predicated on things that will likely take time to manifest. First is that forthcoming new iPhone, the "10th anniversary" variant. If it's a blockbuster it should boost shares even as it leads to hand-wringing about what Apple will do next after that.
But second is that the narrative around Apple's future will have to turn. It could be toward a services business that Apple hopes to make a $50B business by 2021. Or it could be continued growth in wearables that outstrips services and might include augmented-reality parts as soon as next year. Cook notes that competitors are struggling in wearables but that makes it hard for Apple to convince the markets that it alone can fix them. Perhaps Apple's nascent self-driving car effort will start getting appreciated as an option on a trillion-dollar future or its moves into healthcare will be viewed similarly. In essence, though, Apple has to keep proving that doubts around the iPhone are unfounded and it has the next big thing figured out and ready to boom. It won't be easy, but more quarters like this one and it might well be possible.
