Event: Apple is set to report its fiscal Q3 earnings tonight after the close and the options market is implying about a 4.75% one day move* vs the 4 qtr avg of about 6% and the 8 qtr avg of about 5%. (* the July 25th weekly 94 straddle, the call plus the put, went out offered at about $4.40. If you were to buy that into tonight’s report, you would need a $4.40 move in either direction by Friday’s close to break-even, or about 4.75%).
Sentiment: Analysts have gotten increasingly bullish on the stock over the last few months with a series of ratings and price target revisions. There are 46 Buys, 13 Holds and only 3 Sells with an avg 12 month price target of about $103.50, or about 8% higher than current levels.
Options Open Interest: Calls have been much more active over the past month, as the stock has rallied to new 52 week highs. The 1 month average call to put ratio is around 2.25 to 1. In terms of total open interest, calls also outnumber puts, but by a lower margin of about 1.65 to 1.
The six largest strikes of open interest are all calls, and all longer dated with 259k of the Jan15 71.43 calls, 259k of the Jan15 100 calls, 195k Jan15 85.71 calls, 181k Oct 100 calls, 181k Oct 72.14 calls and 157k Oct 96.43 calls. I am surprised that the largest shortest dated strike of open interest is 107,000 of the Aug 100 calls, while the weekly at the money 94.64 strike calls only have about 44k, this will likely be much higher by the end of the today if the stock stays here.
Price Action / Technicals: The stock has had a fabulous turnaround on the year, up 17% ytd and up 32% from the January lows. This rally has been aided by what is likely to amount to (including the quarter just ended) more than $20 billion in share buybacks. The stock went from massive relative under-performer to out-performer over the past year, largely due to enthusiasm about upcoming product cycles, but also the defensive nature of the company’s balance sheet and stable growth prospects.
As far as the charts are concerned, this is the only one that anyone really cares about as the stock is within 7% of the prior all time high made in September of 2012:
Since AAPL’s fiscal Q2 results in April, the stock’s ascent has been very orderly, with a series consolidations that have occurred at $5 increments at $85, $90 and now $95:
It appears that it is a foregone conclusion by most market participants that the stock will once again capture the pre-split level of $700 in the very near future.
Fundamentals / Valuation: For those trying to get their arms around the Apple story, it’s fairly simple. All one needs to focus on is the impending upgrade of the iPhone, which should come in late September for the larger sized 4.7 inch and possibly October or November for the 5.5 inch “phablet”. Just this morning, the WSJ is reporting that Apple has ordered between 70 and 80 million iPhones between the two sizes to be delivered staggered by December 30th. The article suggests that the initial orders for last year’s iPhone 5S and 5C were for 50 to 60 million 4 inch phones, showing this year’s increased confidence of the product cycle. To put this order in some context, Apple sold almost 44 million phones last quarter, and 51 million in the prior quarter that included the first full quarter of 5S and 5C sales.
Analysts project that AAPL will report a record EPS in the fourth quarter of 2014 (projection of $2.32 per share at the moment) as a result of the new product cycle during the holiday season. They have modeled in 9% annual EPS growth in both 2015 and 2016 on sales growth of 7%. If AAPL can achieve those projections, then the stock looks fairly valued at 16x earnings.
In short, the stock’s success likely rests on business execution more than valuation multiple expansion or compression at this juncture. The trailing 12 month P/E is at its highest level since early 2011, when earnings growth was much higher:
Investors expect uninterrupted EPS growth for the foreseeable future, and likely based on improving sales and stable margins rather than simply a lower share count.
Volatility: AAPL’s biggest one day moves over the past year have all been on earnings gaps. The 8% move higher after the April earnings report was its largest on earnings since January 2013. As a result, options traders have bid up implied volatility relative to April:
Implied volatility is likely to fall back to near 20 after the event, UNLESS AAPL breaks out to a new all-time high. In those situations historically, AAPL implied volatility has sometimes risen with price as the price action gets euphoric and volatile.
Our View: Sentiment this year towards Apple’s stock and their prospects has mirrored one another. Prior to the company’s $14 billion accelerated share repurchase in late Jan/early Feb, investors seem resigned to the fact that the company’s lack of new product innovation was here to stay. It seemed that the company would need to financially engineer any meaningful eps growth as Samsung continued to take market share and pressure margins as both compete on price. Well Apple’s Q2 iPhone beat and the upcoming refresh has awoken the sleeping giant. The prior all time high, that this guy thought could take years (not just 2) to recapture, is within striking distance. If the company disappoints on the current quarter, it will most likely be overlooked, and bought on a dip in front of the Sept iPhone 6 launch.
That being said, I think it is important to be mindful that these sort of product launches tend to be a sort of sell the news as was the case in Sept 2012. On the morning that the much anticipated iPhone 5 was released, the stock put in its all time high. So disappointment now will be met with buyers as analysts and investors alike do not expect blowout iPhone guidance in the current quarter. Most new phone buyers, those looking to upgrade or switch from another platform, are likely to wait till Sept/Oct. So if the stock overshoots prior, we would be a tad leery of chasing a runaway breakout.
Bulls will suggest that the iPhone 6 is just the beginning and that iWatch will be coming followed by an iPad refresh. But make no mistake, the hotly defended industry-envied gross margins at Apple could take a hit from all of these newly designed more complicated products, especially when you consider that in the last 5 years, the incremental iPhone and iPad have been evolutionary designs with less complicated manufacturing. That being said Apple has added dozens of new carriers globally since last years launch, and a portfolio of 4, 4.7 and 5.5 inch phones could offer legs to the upgrade cycle beyond the usual 2 quarters. Will China Mobile finally prove to offer the game change status bulls had always expected?
In short, we don’t view a breakout or a breakdown as likely, and expect the stock to trade between $85 and $100 in the coming months. Of course, implied volatility is not at an extreme, so no great structure stands out to us to capitalize on that view. However, if AAPL approaches either end of that range, we would likely be more inclined to buy weakness than sell strength as history has shown trying to pick a top in Apple can be a fools errand.