MorningWord 10/21/14: Watch Out Above – $AAPL

by Dan October 21, 2014 9:30 am • Commentary

Apple has always been a stock that has traded on expectations. Heading into last night’s fiscal Q4 results expectations were high and the company more than delivered.  While Steve Jobs was widely considered to be a visionary on the technology front, it’s still hard to believe that just seven years after the introduction of the iPhone (when the company dumped the “computer” part of its name) Apple would have an equal amount of sales (in the quarter just ended) from selling phones than they had in all of fiscal 2007.  Just staggering.

There was nothing to knock in the quarter and the guidance reported.  The revenue guidance for the current quarter with the top end almost 5% above consensus and gross margin flat sequentially should set a floor for estimates.  The company just refreshed every major product line in the last couple months, and will likely cross-promoting the hell out of Beats hardware.  This will undoubtedly be an Apple Christmas.

At this point, it seems a bit boring to pick on decelerating iPad sales, but I will make one important point. When Apple entered the tablet market in April 2010, the company dominated market share for what was deemed to be a niche high end discretionary product that did not exist to create content, but merely to consume content.  It wasn’t long before lower priced Android offerings chipped away at that marketshare (more than cut in half in the last two years).  That competition has caused the whole category to stall out, leaving companies like Apple scrambling to reinvigorate demand through enterprise partnerships.  So for investors going forward, it may make sense to think about iPads’ decelerating revenue contribution (both units and sales have declined over the last 4 quarters) much like iPod since the release of the iPhone and iPad.

So what’s next?  Watch.  From my earnings preview yesterday:

Top ranked Bernstein Research analyst Toni Sacconaghi Jr … 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.

Watch would need to be an all out hit for it to move the needle in the first year.  Which brings us back to expectations. They are high and will remain high until we get initial sales of the device for which we have no real idea on its release date and pricing.  There will be lots of news surrounding Apple Pay as the launch of the payment service progresses, and I suspect there will be no shortage of complaints about usability.  However, much like all other Apple product releases, the complaints will be blips, and the revenue contribution will not move the needle for some time.

So what to do now??  Was Q1 guidance as good as it gets??  Who knows – the real story for 2015 will be the length of the iPhone 6 upgrade cycle, and that will largely be a function of continued demand in China.

So from a guy who likes to try to find the “chinks in the armor” there were NONE in this quarter or their forward guidance.  Now it is a matter of investor expectations.  If iPhone demand were to slow meaningfully, iPad continues to slow, Mac growth (which has been very impressive; units were 10% better than consensus in the quarter) slows and Watch and Pay launches are just MEH, then you have a stock price that is likely in line with expectations given their massive share buyback, nearly 2% dividend yield and secure positioning in the high-end smartphone market.

All that being said, investors expect sales in fiscal 2015 to be $205 billion, growing 14% year over year, and by the sheer fact that that is such a large portion of global consumer tech hardware sales, it will be very tough to grow that at double digits given the maturation of smartphone market, a category from which the company gets more than 50% of its sales.  So it is my view that you probably don’t chase the stock here, for a trade or an investment trading near $103 in the pre-market.  If you are long, all the power to you, and from where I sit I would merely set a hard stop on the downside at last week’s low of $95:

AAPL five month chart from Bloomberg

As for volatility, today’s relatively subdued reaction to stellar news could be an indication that options are a sale in AAPL.  The stock did not sell off as much as the market on the recent weakness, and strong earnings has not led to a move larger than the implied earnings move.  With that in mind, blindly buying upside calls, as we’ve seen frequently in AAPL, is probably not the right move. As we noted yesterday, the most active options were the November 105 calls, with many of them being sold, could have been long holders overwriting shares, looking to add a little bit of yield for a stock that could be rangebound between last week’s low of $95 and possibly $105, just above the prior high as investors wait the next catalyst.