$AAPL Fiscal Q2 Earnings

by Dan April 26, 2016 11:36 am • Commentary• Trade Ideas

Event: Apple (AAPL) reports fiscal Q2 results tonight after the close. The options market is implying about a 4.5% one day move, which is shy of the implied move prior to their Q1 report in late January of 6.25%, which ended up being nearly inline with the stock’s 6.5% one day post earnings decline. The average move over the last 4 qtrs has been about 3.4%, while the 10 year average has been just a tad shy of 5% a quarter.  The implied move seems fair when you consider the 7% post earnings decline of MSFT last Friday and the 5.4% decline of GOOGL on the same day.

Sentiment: Despite the stock’s 22% decline from its all time highs made last April, Wall Street analysts remain very bullish on the shares with 44 Buys ratings, 4 Holds and only 2 Sell ratings with an average 12 month price target of about $133, very near the all time highs.  It’s been my view that there is a massive disconnect between investor sentiment and that of sell side analysts. While I place little emphasis on a sell side buy rating, when you see so many analysts clustered together, and apparently at odds with investors, it can set up for a blood-letting if there was some sort of material fundamental change to the business causing a massive re-rating of the stock. And on the flip-side, analysts can only raise estimates and targets so much from here. Given AAPL’s massive existing revenue base, there are limits to getting to far ahead of consensus estimates of growth.

From a pure sentiment standpoint, I see few potential headlines that would cause investors to trip over each-other to get back in, and far greater potential for analysts to throw in the towel on their universally bullish stance.
Price Action / Technicals:   AAPL’s 13.5% gains from its 2016 lows, under-performs the 15.5% rally in the S&P 500 (SPX).  This is disappointing when you consider the fact that AAPL is 22% from its all time highs made last year, and the SPX only a couple percent, it’s not a difficult conclusion to draw that AAPL’s stock has lost some mojo. The one year chart below shows the obvious downtrend, and the stock’s recent failure that has yielded a 7% decline in the last 2 weeks:
From Bloomberg
From Bloomberg

On a 10 year basis, AAPL could have downside to its long term uptrend in the mid $80s, while in the near term the upside might be limited to somewhere below the November highs, likely $115ish:

From Bloomberg
From Bloomberg

Fundamentals: I am not going to get into too much new detail, I’ll just link to recent posts (here), but in a word I am skeptical of their ability to maintain their massive margin lead in smartphones as the high end market becomes saturated in a world that is dominated by far cheaper Android based handsets. Last quarter Android devices had an average selling price of $215 vs AAPL’s $691.

And then there is China.  This has probably been the single most controversial issue relating to the stock (aside from iPhone shipments, but they are kind of attached at the hip) since the highs of last 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.

In fiscal Q1’16 (Jan qtr) sales in China were 24% of the total, up 47% sequentially, up only 14%% year/year, vs 2% for the whole.

What’s clear is that growth has massively decelerated, and it may be that AAPL has already sold an iPhone to just about every Chinese person who can afford one.  And as I discussed in a post last week, other massive emerging markets like India and Indonesia may have very different barriers than those they navigated in their ramp in China the last couple years (read here).

My View into the Print:

The technical set up is poor at best. Investor sentiment is also poor, which sets up for a relief rally if results and guidance are not as bad as expected.  That said, investors clearly have one finger on the trigger, and if investors were to sell on slower growth prospects, I suspect the sell-side might re-rate the stock lower en-masse. And that could mean we see the stock once again with a 9 handle.  I’d place a low probability on the outcome that the stock massively outperforms the implied move to the upside, and a slightly higher (but still low probability) that the stock is down far greater than the implied move. So I’m assuming a bit of asymmetry in large moves higher vs lower on the report but a likely base case scenario that the stock is simply up or down 5%. But that is still a whopping $30 billion in either direction.

Ok for those who are looking for the answer key whether to buy, short, or reduce long exposure prior to the print, well my crystal ball is a bit a fuzzy. I am not inclined to trade the event itself. I don’t like pressing weak stocks into events, but I see little reason why a relief rally would stick. I’d probably be more inclined to sell a relief rally back towards $110, and probably not that inclined to buy a sell off in the high $90s, I’d love to see low $90s on a flush for a long entry.

We will follow up this post with one that includes options overlays for existing longs, or trade ideas for those with a directional inclination into the print.