Event: Apple (AAPL) reports its fiscal Q4 results tonight after the close. The options market is implying about a 3.5% one day move and weekly move of about 4.5%* which is shy of the 4 & 8 quarter averages of about 5%.
*The implied move can be figured out by taking the cost of the weekly at the money straddle (the sum of the Put and Call of the same strike in the same expiration) and dividing by the stock price. At the moment, with AAPL at $98, the Oct 24th weekly 98 call is offered at $2.25, and the Oct 24th weekly 98 put $2.25. If you bought the straddle for $4.50, you would need a $4.50 / ~4.5% move in either direction (above $102.50, or below $93.50) to break-even.
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 47 Buys, 11 Holds and only 5 Sells with an avg 12 month price target of about $112 (which is about 9% higher than the avg target in mid July prior to Q3 results when the stock was around $95, vs Friday’s close of $97.67).
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 1.5 to 1. Eight of the ten largest strikes of open interest are calls, with the single largest strike of open interest 243,000 of the Jan15 100 calls.
Price Action / Technicals: Apple has been a massive outperformer in the last six months, up 30% since April 22nd, the day the company released their fiscal Q2 results, and up 22% on the year vs the Nasdaq Composite which is up only 2%.
Despite making a new all time high in early September, the stock has made a series of lower highs and lower lows, but nothing particularly extraordinary in either direction and has remained in a fairly tight range. From the stock’s high on Sept 3rd to Wednesday’s two month low just above $95, the stock sold off about 8%, a tad less than the 10% sell off in the S&P 500 and the Nasdaq Composite from their Sept highs.
The $95 to $90 range could become an increasingly important near term technical support range with $95 the June high and last week’s low and $90 the June low:
The five month chart below showing the new all time high made in early September (circled in green) also shows what could be waning momentum from that high with two lower highs put in since, and two lower lows:
Fundamentals / Valuation: It’s not lost on anyone that Apple, aside from closing the Beats acquisition, has just recently refreshed EVERY major product category (iPhone, Mac/MacAir & iPad) in front of the holiday season and introduced their first new category since the iPad (the Watch not to be released until early 2015) in April 2010. To suggest that Apple products will DOMINATE holiday sales is likely an understatement, but I think it is important to note that they will probably be competing mostly with themselves as many of their new products and price points are likely to cannibalize one another. For instance, low end iPads will be viewed as competition for iPhone dollars. High end iPads will compete for 11 & 13 inch MacAir dollars. iPods, well they will be gone soon.
The table below shows Apple’s sales quarter by quarter and year over year since 2009, what is blatantly obvious and largely one of the big reasons for the stock’s 45% peak to trough decline in 2012/2013, was that the company hit a growth wall. Sales that were growing at a 50 – 70% pace after the intro of the iPhone, and the iPad slowed dramatically:
As Apple got a greater and greater percentage of the rapidly growing smartphone pie, and a disproportionate amount of the high end market’s profit, competitors started to compete on price, pressuring margins. Apple’s company wide Gross margin peaked in Q2 fiscal 2012, with fiscal 2014 gross margins expected to be 5 points lower:
The deceleration in sales growth and the margin decline has caused a decline in net income from a high of $41.73B in fiscal 2012 to this years expected $38.9B:
But earnings are expected to be basically flat from the end of fiscal 2012 as the company has bought back nearly $60 billion worth of stock, aiding the earnings per share number ($6.31 in 2012, expected $6.34 this year just ended):
Ok, so that’s the past. Let’s get to expectations. They are not low. Given the product refreshes and launch of larger iPhone 6 and Plus in China could aid some sort of re-acceleration in earnings, net income & sales growth, with consensus for fiscal 2015 (current year) up 16%, 12% and 10% sequentially. Point here is that double digit sales growth on an expected $200 billion base is gonna be tough to come by from here on out. Think of it this way, iPhone is 50% of their sales, to maintain that level, and create new categories to replace declining iPad sales at about 15%, Apple is going to need to see fairly unexpected UPSIDE from Watch and services like Apple Pay for the company to see double digit sales growth from here. Per MacRumors.com in fiscal Q3:
So is Watch gonna be the thing to do it?? Top ranked Bernstein Research analyst Toni Sacconaghi Jr doesn’t seem to think so (at least not in the current fiscal year. In a research note on October 16th he suggested that despite not having Watch in his FY 2015 estimates:
we think the company could potentially sell 15 million units in the first year of introduction, assuming a $450 ASP. This yields revenue of $6.75B and EPS of $0.30, which adds 3-4% to our FY15 estimates.
So while they could certainly be a nice start off of the existing base, it does not speak to how much it will offset declining iPad sales, and what is likely a drag on margins initially.
I think it is safe to say that expectations have risen of late, once the glow of the iPhone 6 and 6 Plus replacement cycle starts to wane, we could see the law of large numbers kick in once again as the high end smartphone and tablet market continues to mature in what is an already saturated landscape in the North America and Europe.
What to say on valuation? Right, its cheap, like it has been for the last 10 years and like every other large cap tech stock. AAPL trades at about 16x trailing earnings and 13x forward on expected EPS growth of 16%. Despite forward being below a market multiple, and much below ex-cash, this is nearly the high over the last five years. I would also note that organic EPS growth in what has been a declining gross margin and net income period, is likely the result of the tens of billions of dollars in share buybacks over the last two years.
Volatility: the price of options in AAPL this past week nearly reached 52 week highs as the S&P500 approached the 10% correction level, but have since settled in a tad (despite today’s earnings event.) What’s interesting when looking at the chart below of 30 day at the money Implied Volatlity (IV) is that unlike many other tech companies that see IV spike 4 times a year prior to earnings, AAPL holds scheduled product launch events that produce vol bids as big or bigger than earnings. The chart below shows IV rising in September in front of the iPhone 6 launch event, and the subsequent decline. This behavior is somewhat predictable, and gives traders a sense for how exactly options premium should perform in and around events.
The one day move of about 3.5% seems about fair.
Our View: While we believe expectations are probably as high as they have been for the company in two years we think that investors will disregard any miscues in fiscal Q4, and focus on fiscal Q1 and fiscal 2015 guidance. While investors have become accustomed to the company sandbagging guidance (giving very conservative guidance that they can beat) it is important to note that Tim Cook has stated in the not to distant past that he wants to give “realistic” guidance.
In a market that has recently seen some prior tech leaders fall by the wayside (Google earnings miss and subsequent decline placing it down on year, NFLX crushed on a subscriber miss and INTC sold off despite a beat) it may take a solid beat and raise for AAPL to make a new high from here.
To be fair, despite AAPL’s 8% decline from its Sept 3rd all time high the stock acted fairly well on a relative basis in the last week. When the broad market appeared to be at its most panicky, AAPL stock almost appeared to act a defensive with their strong commitment to cash return as a result of that fat cash balance and 2% dividend yield.
So as you know, great company, great products, great management, nice road map to expand ecosystem to wearable and services, but I suspect that with the stock back near the prior 2012 highs, Apple could be a show me story once we have realistic 2015 guidance on the table. It is my belief that iPhone 6 upgrade will be an initial boon for units but could quickly revert back to normal sales cycles, that iPad is a category that will likely see flat to declining unit growth for some time. Wearables will likely cannibalize iPads a bit during Christmas gift season and services like Pay will have their share of glitches and will not move the needle on the eps and revenue front for some time.
I would also add that a flop on the Watch could be a massive wake up call to those who have suggested that Apple remains a hotbed of innovation. I believe that the release of a product that would not have passed the Steve Jobs “smell test” poses more risk on a failure than that of a moderate success. Investors and consumers have come to accept great products, I am not sure that is what we are going to get with the first watch that can’t even operate as a standalone.
So where am I on the stock? I suspect that it is a low probability that the stock makes a new all time high this week on the results. I think the base case scenario is that the stock is between the low $90s and possibly $102 and that the risk is to the downside on a miss and a weak guide.
I do not currently have a position in the stock or options, but would probably be inclined to sell the weekly implied move of about 4.5% as that is likely the highest probability trade this week.
Looking out a bit, I would be a buyer on a break down back towards the unchanged mark on the year in in the event of a stock specific disappointment and/or broad market sell off (again likely a low probability event in the next couple weeks.) If the company were to issue realistic guidance and the stock were to base between $90 and $100 for some time I would deem this to be healthy consolidation of its ytd gains just below the prior highs and at that point I would possibly look to play for a breakout. For now though, lets see if the company’s confidence matches that of investors expectations.
AAPL 4Q14 Preview
Revenue: $39.8 billion (AAPL guidance: $37-40 billion range/Consensus: $39.9 billion)
Gross Margin: 38.0% (AAPL guidance: 37-38% range)
EPS: $1.32 (Consensus: $1.31)
Product Unit Sales and Commentary
Macs: 5.0 million (9% yoy growth)
iPad: 12.4 million (12% yoy decline. Consensus is closer to 13 million.)
iPod: 1.7 million (50% yoy decline)
iPhone: 36.5 million (8% yoy growth. Consensus is closer to 37-38 million.)