Event: Apple (AAPL) reports fiscal Q1 results tonight after the close. The options market is implying about a 6.25% one day move, which is basically inline with the implied move prior to their Q4 report in late October of 6.5%. That October report subsequently saw a post earnings rally of 4.12%. The average move over the last 4 qtrs has been about 4%, while the 10 year average has been just a tad shy of 5% a quarter.
Sentiment: Despite the stock’s 26% decline from its all time highs in April, Wall Street analysts remain very bullish on the shares with 45 Buys ratings, 6 Holds and only 1 Sell with an average 12 month price target of about $141 (down about $7 since the day of their Q4 print in Oct), or about 30% higher than current levels.
There appears to be diverging sentiment among the stock’s largest shareholders and that of the relentlessly bullish Wall Street Analysts. Just look at the latest filings, 13 (11 meaningfully) of the 20 largest holders reduced their stake in AAPL, while only 5 raised it (only 2 meaningfully):
Price Action / Technicals: AAPL is down 5.5% on the year, besting the S&P 500 (SPX) which is down about 8% and the Nasdaq Composite which is down about 10%.
Interestingly, when the SPX made a fresh low during last Wednesday’s drubbing (lower than its flash crash low on Aug 24th) AAPL did not make a new intra-day low, another indication that the stock is trying its best to show some relative strength. I would also highlight on the upside, the importance near term of $110, the level the stock broke below in late August, and then again late last year, paving the way for a 15% decline into Wednesday’s lows:
The five year chart shows the importance of $100, which was the top in September 2012. That failure in 2012 yielded a peak to trough decline of 45%. With AAPL now back at $100 that could become formidable near term technical resistance. I would add that the stock is now straddling the uptrend from the 2013 lows, with little support below:
And lastly, the 10 year chart, which depending how you draw the lines, I see the potential for a move back to the long term uptrend from the financial crisis lows, somewhere in the mid to low $80s:
Fundamentals: I am going to reiterate (but also augment) some thoughts I had in a post from September 29th, AAPL Turnover, where I touched on what I feel are the key factors currently holding back the stock. Few of the topics have changed, while some have increased in importance:
- iPhone Unit Growth: The iPhone 6 & 6 plus’s increase in size caused a massive upgrade cycle over the past year. Size was the thing iPhone was lacking in most markets outside the U.S. Comparisons to last year’s unit growth of 25% will be tough off of such a large base with what appears to be a very incremental upgrade. So the big fear is that iPhone unit growth will slow at a time where new iPad, wearables and services have shown little signs to pick up the slack.
- Buybacks and dividends: 80 some percent of the company’s $205 billion in cash is overseas, to increase and continue to fund their existing $200 billion commitment. In the Sept quarter the company returned $17 billion to shareholders through buybacks and dividends (vs operating cash flow in the quarter of $13.5 billion), bringing the total returned under the existing plan to $143 billion. I suspect with the stock declining for most of the last 4 months, the company has been aggressively buying back stock, they will need to add to their $65 billion debt load, or step up the rhetoric for an offshore tax amnesty.
- Earnings and Sales Growth: Even with these buybacks, AAPL is only expected to grow earnings 3% year over year in fiscal 2016 (with expected sales growth of 1%), this has come down of mid to single digits for both in the last couple months.
- U.S. Dollar will remain a headwind as much of AAPL’s growth is to come from overseas: 60% of AAPL’s sales last year came from outside the U.S., this is only increasing, while China represents about 25% of total iPhone sales. It’s our view that dollar strength is here to stay in the global economic environment we are in. That’s why one of the most important charts for AAPL going forward might be the Chinese Renminbi (yuan) vs the U.S. Dollar, which we all know has been moving in the wrong direction for foreign companies who sell into China:
Oh and one more thing on China. This has probably been the single most controversial issue relating to the stock since the highs in the Spring, as sales in the country over the last year have been triple if not quadruple that of the company’s revenue growth rate:
In fiscal Q1’15 (Dec qtr) sales in China were 22% of the total, up 157% sequentially, up 70% year over year vs up 30% for the whole.
In fiscal Q2’15 (Mar qtr) sales in China were 29% of the total, up 4% sequentially, up 71% year over year, vs 27% for the whole.
In fiscal Q3’15 (Jun qtr) sales in China were 27% of the total, down 21% sequentially, up 112% year over year, vs 33% for the whole.
In fiscal Q4’15 (Sept qtr) sales in China were 24% of the total, down 5% sequentially, up 99% year/year, vs 22% for the whole.
And as I suggested in late September:
It feels like Tim Cook has placed AAPL’s future on the growing middle class in China. But while China remains a long term growth opportunity, in the near term, it could be a stumbling block if Chinese consumption takes a hit. The fact that an iPhone costs nearly 14% of the annual household income in China means iPhones can go from the aspirational product they’ve become, back into a luxury product they were a few years ago.
That little business of CEO Tim Cook putting himself out there on China growth in his August email to CNBC’s Jim Cramer? Well, that’s the sort of thing that could dog him for quarters, if not years.
MY VIEW INTO THE PRINT:
To be 100% honest, I’d much rather be long AAPL after its results and guidance than the S&P 500 given their balance sheet, valuation, commitment to cash return (dividend yield in line with the SPX & the 10 year Treasury yield), dominant position in the high-end smartphone market and tremendous longer term growth potential in emerging markets. But it’s my view that the stock which trades 10.5x earnings, less than 9x ex-cash, is not a “NO-BRAINER” until sell-side sentiment comes in line with that of investors, who clearly are less than enthusiastic about the stock. The stock has traded well below a market multiple, its whole way up, and its whole way down over the last couple years. So we get it, the stock is always cheap as investors have discounted their massive pile of cash.
It’s my view that aside from some sort of miracle in emerging markets, the only way the stock will see multiple expansion in the near term is a combination of unlocking some value from existing apps and web services, as I detailed in a post in Nov (here):
if I were Tim Cook, given the saturation of the high-end smartphone market, the declining growth of iPad and the tepid response to the Watch, Apps and Services, as I have and many others have opined in the past, is the next opportunity for double digit revenue growth for the company. I get it, the integration of Apple’s software to its hardware makes it unique to Android, but I am not sure it outweighs the potential monetization outside its current installed hardware base. It’s my sense that a formidable multi-platform app ecosystem could serve as a sort of trojan horse for Apple as users on Android may accelerate the trend of “switching” to Apple’s ecosystem if they have access to their apps and services. Additionally, Facebook has proven an ability to monetize many of these apps and services, or have paid very high premiums on the belief they can do so in the future. Google generates billions of dollars a year advertising on iOS devices. If Apple were to tap into their massive hardware ecosystem, and monetize their users with their unique services, then they should quickly buy Snapchat and Twitter and start building an App/social ecosystem for quickly evolving mobile landscape which is seeing less and less differentiation on the hardware front.
But none of that is going to happen anytime soon. SO for now, I suspect that at current levels a Q1 iPhone unit miss is in the price just below $100, but it’s also my view that upside forward guidance will be very hard to come by given the state of emerging markets and the adverse affect of the U.S. dollar. If sentiment is poor enough that a sib 75 million iPhone unit price is in the stock, investors will need to be reassured that the introduction of the new lower priced, smaller size iPhone expected in March/April, that with a mix back towards iPhone 6s, from 6 plus does not cause (with dollar strength) a material hit to gross margins. If the company can guide inline, given the building headwinds in an increasingly saturated high end smartphone market, then the stock’s decline is likely halted, for now.
But if the stock does have a relief rally on merely inline guidance, then I think it gets sold, one quarter of past results and forward guidance that are not as bad as expected is not gonna make this aircraft carrier turn on a dime. I expect the stock to trade with an 8 handle at some point in the coming weeks/months, and any bounce to $110/$115 should be sold.
On Friday we laid out a defensive collar for long holders (read here) and we would probably buy a put spread instead of a straight put against long stock in this structure to get closer to the money protection. I described the strategy on Friday’s Options Action, but we will be sure to offer some directional trade ideas before the close:
Estimates & Forecasts from Bloomberg:
-1Q EPS est. $3.23 (range $2.83-$3.44); avg. est. down ~0.7% over past 4 weeks
-1Q rev. est. $76.6b (range $70.6b-$80.0m); AAPL forecast $75.5b-$77.5b
-1Q gross margin est. 39.9% (range 38.8%-42.0%); AAPL forecast 39%-40%
-2Q EPS est. $2.24 (range $1.72-$2.96); avg. est. down ~6.6% over past 4 weeks
-2Q rev. est. $55.7b (range $49.5b-$64.7b); avg. est. down ~5.3% over past 4 weeks
-2Q gross margin est. ~40.0% (range 38.3%-41.5%)
-1Q iPhone unit est. 75.0m (9 ests.)
-iPhone ASP est. ~$674 (5 ests.)
-1Q iPad unit est. 17.3m (7 ests.)
-iPad ASP est. ~$467 (4 ests.)
-1Q Mac unit est. 5.8m (7 ests.)
-1Q Watch est. 5.3m (3 ests.)
DISCLOSURE: I have no position in AAPL stock or options. I am long 2 dozen Apple products accumulated over the last 5 years (business and personal), and a very happy customer.