Event: Apple (AAPL) reports its fiscal Q1 results tonight after the close. The options market is implying about a 5% one day move (and weekly move of about 6%) which is a tad shy of the 4 & 8 quarter average earnings moves of about 5.25%.
*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 $113.10, the Jan30th weekly 113 call is offered at $3.50, and the Jan30th weekly 113 put at $3.40. If you bought the straddle for $6.90, you would need a $6.90 / ~6% move in either direction (above $119.90, or below $106.10) to break-even for the week. The one day move post results will obviously be a bit less than the weekly (which is really just three trading days).
Sentiment: Analysts remain very bullish on the shares with 47 Buys ratings, 13 Holds and only 4 Sells with an average 12 month price target of about $124 (which is about 9% higher than the avg target in mid October prior to Q4 results when the stock was around $98).
Options Open Interest: Calls have been much more active over the past month, despite the stock trading within a $105 and $115 range. The 1 month average call to put ratio is around 1.75 to 1. Nine of the ten largest strikes of open interest are calls, with the two largest strikes of open interest 181,000 of the March 115 calls and 172,000 Feb 120 calls.
Price Action / Technicals: A year ago heading into AAPL’s fiscal Q1 report, sentiment towards the stock could not have been more different than it is now. With shares hovering just below $80, the company’s Q2 guidance sent the stock down 8% the next day, and it wasn’t until the company engaged in an aggressive accelerated share buyback (purchasing $16 billion worth of stock in a matter of days/weeks) that the stock finally bottomed and started its eye-popping run into the iPhone 6 announcement and launch in the fall gaining 69% (or about $400 billion in market cap) from the Jan lows to the November highs:
On a near term basis I think its safe to say that despite AAPL showing mild outperformance to the Nasdaq Composite ytd (up 2.5% vs the Nas up 75 bps) the stock has been treading water since the November all time highs, seemingly in a downtrend making a series of lower highs and lower lows, until Friday’s close:
What’s interesting about the pricing of the at the money weekly straddle is that on the upper end it brings you right back to the prior highs at $120, and on the lower end it brings you back to what looks like near term technical support at $105, a level the stock has traded to and bounced from on two occasions in the last month. The logical longer term support would be back to the psychologically important $100 level, which is just above the stock’s 200 day moving average (yellow line above) and which also corresponds to the breakout level following the Q4 results in October.
I would add one more point heading into the Q1 print and Q2 guidance, the two worst one day declines in AAPL in the last two years have come in January, one following last year’s Q1 print on Jan 27th 2014, and a 12% decline on Jan 23rd, 2013 following AAPL’s fiscal Q2’13 guidance.
Fundamentals / Valuation: As for fundamentals, I think I’ll start with a quote from my Q1 preview in October about AAPL’s positioning into the Holiday Season:
AAPL….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.
I think it is safe to say that expectations are very high, and it is highly unlikely for the company to disappoint on more than a couple metrics. iPhone unit sales, gross margins (as usual) and Q2 guidance are the three things to watch. I suspect that the whisper for iPhone units close to 70 million, representing 35% year over year growth (consensus around 65 million) could be a stretch and set up for a mild disappointment, while it seems that margins could have trended higher due to mix shift with larger iPhones. And guidance is anyone’s guess. I suspect the iPhone upgrade cycle has legs outside the U.S., and the introduction of Watch in Q2 could offer a $2-4 billion bump in sales.
On valuation, it’s still cheap, but that’s a relative term when speaking about mega cap tech aside from Alibaba & Facebook. AAPL trades at about 14.5x expected 2015 EPS growth of 21% on expected sales growth of 17%. Despite 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 the result of the tens of billions of dollars in share buybacks over the last two years.
Volatility: Short dated vol is elevated heading into the print, which is evident with the almost 5% one day implied move vs last quarter’s 3.5% implied move. To put the 5% move in some context, the options market is expects a $33 billion market cap move in either direction. Expressing near term directional views with options will be a tough way to make money, while yield enhancement strategies like overwrites could be attractive:
My View: Expectations are as high as they have been for the company since the fall of 2012. While investors have become accustomed to the company sandbagging guidance it is important to note that Tim Cook has clearly stated that he wants to give “realistic” guidance that should be taken at face value.
From October, not much has changed, aside from the fact that consensus is much higher, apparently confident in Watch being a mild hit and PAY making serious inroads:
So as you know, great company, great products, great management, nice roadmap 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.
Oh and I stick by this non-consensus view:
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.
In the near term a beat and raise would easily send the stock back to the prior high at $120, but I suspect it could see some resistance there. Will the stock run into a Watch launch? I suspect it will so you can say bye-bye to the prior highs but at that point I foresee few product catalysts until September when we get the S update of iPhone 6.
So investors will have Watch, updates on PAY uptake, likely update to cash return in April and then the expected product updates. Definitely enough to sustain the stock at current levels and make new highs without any hiccups.
Going forward though I suspect that AAPL’s below market and peer multiple reflects the long term fears that I have not been shy to point out given what I feel is the mobile landscape shifting below AAPL’s feet, but we can save that discussion for another day. iPad has gone ex-growth, iPod is all but gone, iPhone will face stiff competition in parts of the world where AAPL will be hard pressed to get a 50% gross margin on a smartphone with a $600 plus ASP. Yeah, a suite of services are all around, media, payments, messaging etc etc are all great but will likely take years to move the needle. Wearables, yeah they are huge, they are the category that takes this stake to that $1 trillion level, but I am not sure the world will be believers in AAPL’s ability to deliver on their promise of fantastic innovation given what we already know of the first iteration of the device.
Believe it or not right here I am pretty neutral on the stock, I get the div yield, the balance sheet, the upgrade cycle, the market share gains in Mac, the hope for increased buybacks, PAY & services taking off, wearables being a runaway success. But one thing I am fairly certain is that the high-end smartphone market is likely to become a lot more competitive very soon, and AAPL for now is an iPhone company and will need to hold onto that margin or the stock will be re-rated very quickly as it was in late 2012/2013.
Near term I probably look to fade a move to $120 post results and would possibly even be a buyer near $100 if it got there for the wrong reasons.
Obviously AAPL’s commentary about foreign exchange headwinds will be very closely watched after the disasters we have seen so far this week from UPS, PG, CAT and MSFT, IN fiscal 2014 35% of AAPL’s sales came from the Americas, and less from America!
Estimates & Guidance, per Bloomberg:
-1Q EPS est. $2.60 (range $2.45-$2.97); avg est. up 2.2% over past 4 weeks
-1Q rev. est. $67.52b (range $65.01b-$74.27b); AAPL forecast $63.5b-$66.5b
-1Q gross margin est. 38.5% (range 38%-40%); AAPL forecast 37.5%-38.5%
-2Q EPS est. $2.00 (range $1.65-$2.38); avg est. up 0.8% over past four weeks
-2Q rev. est. $53.70b (range $46.64b-$59.08b); avg est. up 0.6% over past four weeks
-2Q gross margin est. 38.6% (range 37%-40%)
Product Unit Sales Estimates:
Macs: ~5.0 million
iPad: ~22 million
iPod: ~1.6 million
iPhone: ~65 million