Event: AAPL reports their fiscal Q3 earnings tomorrow night (July 23rd) after the close. The options market is implying about a 4% one day move, which is just a tad shy to the 4 qtr avg of about 4.4% and the 8 qtr avg of ~5%.
Sentiment: Wall Street analysts’ resolve for their bullish ratings on the stock remains intact with 49 Buys, 14 Holds and 3 sells with an avg 12 month price target of ~$528. This compares with 49 Buys, 5 Holds and 1 Sell with an avg 12 month price target of $735, last July the day before the Q3 report when the stock closed at $600. As you can see that despite the stock;s 40% decline from the Sept highs, analyst remain similarly positioned, with price targets ~22% above current price.
Short interest sits at about 3% of the float, its highest level in the past 5 years, but still relatively low compared to most stocks.
Options Open Interest: As usual for AAPL, calls handily outnumber puts in open interest. About 1.45m in call open interest, vs. around 900k for puts. Recent activity has been in line with AAPL’s history during 2013 – the call to put activity ratio over the last month is about 1.45.
Price Action / Technicals: The 435 level has been a pivot area for AAPL stock throughout 2013. Since the stock’s decline after its January earnings report, it has spent about half of its time above 435 and about half of its time below that level. On its most recent rally, that level acted as resistance:
The stock found buyers around the 385-390 on its last two dips below $400, and that’s the key level to watch on the downside. On the upside, 465 is the obvious level that traders are watching after the failed rallies in March and May near that price.
390 has added importance because it also coincides with AAPL’s 200 week moving average. AAPL stock has not traded below there since March 2009:
Finally, AAPL traded between 350 and 400 for much of the latter half of 2011, so a lot of transaction volume in that area as well.
Fundamentals/Expectations: Analysts expect AAPL to have its first year over year earnings decline in 10 years this year as the company is trying to manage a declining margin structure, that while decelerating is still nearly double that of its nearest competitor. Analysts will most likely be very focused on getting clues as to the mix of iPhone’s sold as the greater percentage of iPhone 5s will help them extrapolate a higher gross margin as we head into an expected upgrade cycle this fall with the expected iPhone 5s.
VZ reported last week and saw a nice mix shift of new iPhone activation, last qtr the iPhone 5 was ~50%, while this qtr was ~70%, this should help ASP (average selling prices) which most analyst expect to decline sequentially.
T0 get a sense for what is “IN” the stock, down ~20% on the year and ~40% from the Sept highs, it makes sense to get familiar with what the company has guided this qtr to, and how bad the current qtr guidance could be. Lets start with the guidance for fiscal Q3 that was given in April from their Q2 earnings release:
- revenue between $33.5 billion and $35.5 billion
- gross margin between 36 percent and 37 percent
- operating expenses between $3.85 billion and $3.95 billion
- other income/(expense) of $300 million
- tax rate of 26%
Analysts consensus (Bloomberg):
- revenue ~$35b, at the high end of the guidance range, which would be flat year over year,
- gross margin ~36.7%, a 14% decline yoy
- EPS $7.31 which would be better than the mid point of the implied guidance range of $6.60 to $7.50, but represent a yoy decline of 22%.
Top rated Bernstein analyst Toni Sacconaghi, who rates the shares a Buy with a $600 12 month price target suggested in a note to clients last week dated 7/16/13:
Gross margins remain the key investment controversy surrounding AAPL, and a key plank of the bear thesis is that Apple is over-earning because of unsustainably high gross margins, and that competition in the smartphone and tablet space will (1) lead to a lower price/lower margin mix of SKUs; (2) pressure to make more competitive and higher COGs products going forward, and (3) result in shorter product cycles that will limit Apple’s ability to capture component cost declines. The bull case – by contrast – believes that Apple’s margins on current products will stabilize around current levels, with movement higher or lower depending on where Apple is on product cost curves.
Sacconaghi goes on to talk about expectations for the current quarter and the likelihood of AAPL continuing to provide “realistic” guidance as they call it and the width of the range could dictate the chance of new products in the qtr:
Apple’s potential Q4 guidance range is huge – ranging possibly from $6 to $10 in EPS – depending on whether any new products begin shipping in the quarter. If guidance is weak, it suggests new products will likely be announced in September or October, contributing to a lull in Q4 sales and EPS; conversely, strong guidance likely presages new products beginning to ship in September, which could trigger positive revisions and investor enthusiasm. It is possible that Apple might get a “free pass” on weak Q4 guidance, particularly if it alludes to significant new offerings in October, but it will depend on how solid Q3 results ultimately are, and where Q4 guidance ultimately lands.
Consensus for Q4 from Bloomberg:
- 4Q EPS est. $7.99 (range $6.46-$10.48; avg est. down 2% over past four weeks)
- 4Q rev. est. $37.26b (range $34.0b-$43.88b; avg est. down 2% over past four weeks)
- 4Q gross margin 36.7% (range 34.5%-38.2%)
UNIT BREAKDOWN from Bloomberg:
- 3Q iPhone unit est. 26.1m (range 23m-29m, 16 ests.)
- iPhone ASP $597 (10 ests.)
- 3Q iPad unit est. 17.4m (range 13.5m-21.1m, 16 ests.)
- iPad ASP $433 (10 ests.)
- 3Q Mac unit est. 3.9m (12 ests.)
- 3Q iPod unit est. 4.9m (12 ests.)
Volatility: Implied vol is very low for an earnings event historically. This could reflect a new consensus that AAPL has found a range and stabilized since it’s dramatic selloff from the highs. August vol is about 28 which is the lowest front month vol has been for an earnings event over the last 2 years. Here’s the 2 year chart with IV30 in red and Earnings noted:
Expect August vol to fall to the low 20’s the day after or a little over 20%.
My View: First things first, despite AAPL’s amazingly strong balance sheet and cash generation (generated $12.50 b in free cash flow last qtr alone), the company’s fundamentals are probably as challenged at any time in the last ten years. That being said, 2 of the key issues for AAPL’s future growth, smartphone saturation & margin deceleration are very well known and bulls would argue this is why the stock trades at 10x earnings and only 1.5x ev/sales (not exactly apples to apples, but MSFT trades at 2.6x and GOOG trades at 4.4x). The stock is cheap, with a massive cash hoard, $60 billion share repurchase and a dividend yield of 2.85%.
As we said heading into last qtrs print, we think the stock is a hard press at current levels on the short side, there is a good bit of known bad news in the stock. Prior to the bounce from below $400 earlier this month, I was frankly shocked that there is anyone left who wants to sell who hasn’t done so already. Some of the issues facing the stock late last year and early this year have morphed a bit from competition based, to known based in the fact that the entire market may be saturated with high end smartphones, even now affecting the likes of Samsung (down 16% on the year) not to mention NOK, BBRY, and GOOG’s issues with MOT.
Enis, CC and I have a slightly different view on the stock at current levels, they are much less inclined to view the stock in a negative light, but despite the poor investor sentiment, cheap valuation and far better than average chance of coming up with a new innovative product, it has been my belief that until the sell side capitulates on the name, the technical backdrop is still too weak to call a bottom. Despite Enis’ nice charting above showing a very defined trading range in the stock btwn $350 and $435/$465, I can’t help but highlight the 5 year chart which to my eye shows either a stock that is ready to bounce to $500 or collapse to $325.
As CC likes to say, you don’t get any extra points in trading for “degree of difficulty” in calling for slightly more weakness after such a sharp selloff, but I just don’t see the downdraft in the stock is done until we get either price or analyst capitulation. One thing I will say that I am fairly sure of, the stock will not bottom on an inline qtr and guidance, it will likely take a beat and raise with the follow up of a new unexpected product or distribution deal with China Mobile. It will be a process, and incrementally better results after a period of a few misses will not do the trick.
My sense is to avoid trying to pick a near term term bottom into a quarter that is likely to disappoint, at least on the guidance front, but with implied vol as low as it is, playing directionally or even taking a shot on the move could make sense. For those of you who are investors, if you are willing to close your eyes for a year or so, and collect the dividend, with the knowledge of the company’s commitment to buy back shares, and eventually hit a product cycle, I would tell you that I would much rather buy AAPL than almost 95% of U.S. equities, and if I get the capitulation that I am hoping for, will do so myself. But in the meantime I think the low volatility is a correct reflection that AAPL may be a stock you want to buy at recent lows and sell at recent highs until proven otherwise.