Event: Apple (AAPL) reports their fiscal Q3 results tonight after the close. The options market is implying about a 4% move in either direction*, which is shy to the average of about 5.5% over the last 4 quarters, and shy to the 10 year average of about 4.8%. AAPL has declined the day following 4 of the last 5 results and on average 6.35% over the last two quarterly reports.
*With the stock at $97.45, the July 29th weekly 97.50 straddle (the call premium + the put premium) is offered at $4, if you bought that (which is almost all essentially the implied earnings move) you would need a move above $101.50 or below $93.50 by Friday’s close to break-even.
Price Action / Technicals:
AAPL has woefully under-performed the broad market since making a new all time high in April of 2015. It is now down 28% from those levels, and down 7.5% in 2016.
Since the stock’s late April earnings gap following disappointing Q2 results and guidance, the stock has been range-bound between $100 and $90, right now trading at the almost exact mid point of the range since the day prior to Q2 results:
If the stock were to move following tonight’s print inline with the 6.35% move of the last two quarters, that puts the stock far close to a gap fill from April to the upside or a re-test of support near $91 on the downside.
But let’s not sugarcoat the technical set up. Even if the stock gets a relief rally to $104/$105, it remains challenged. The stock has made a series of lower highs and lowers lows showing poor relative strength for more than a year.
There is a massive air-pocket below 2 year support in the low $90s, which brings you down to the long term uptrend that has been in place since AAPL’s lows in 2009:
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 dominated by far cheaper Android based handsets. Last quarter, Android devices had an average selling price of $215 vs AAPL’s $645.
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. Sales in the country in 2015 had been 3x/4x that of the company’s revenue growth rate, which has not moderated substantially:
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.
In fiscal Q2’16 (Apr qtr) sales in China were 25% of the total, down 32% sequentially, down 26% year/year, vs down 13% year/year for the whole company.
Has AAPL already sold an iPhone to most of the people in China that can afford one? And as I discussed in a couple posts in April, other massive emerging markets like India and Indonesia have different challenges due to demographics. Those countries have a different playbook than their ramp in China the last couple years (read here).
Regular readers know that I don’t love AAPL’s near term prospects to turn around iPhone sales. It’s expected that this will be its first year over year decline in units. Rumors point to the company releasing an iPhone in late Sept with the same form factor for a third straight iteration, essentially extending the existing product cycle.
And I would add that AAPL’s release of the lower cost iPhone SE a few months back, basically a souped up iPhone 5s, at a lower price point is probably their most important product launch since the iPad in 2010, despite being its least innovative. Why you ask? Because they are getting smoked by lower cost smartphones in emerging markets (Android worldwide ASPs last quarter were $215 vs AAPL’s at $645). On this point they seem to be doing one thing and saying another. India has a population of 1.3 billion, and very low 3G and smartphone penetration (more on that here) but on AAPL’s last earnings call in late April, CEO Tim Cook said that the market in India:
“is where China was 7 to 10 years ago”
Here’s my thoughts on why the lower cost phone matters for the company, from an April 27th post:
If that is the case it may take just a few more years for AAPL’s sales in India to move the needle on their current $200+ billion in sales in the current fiscal year. AAPL introduced the iPhone 3GS in China in 2009, and total sales in the region were less than 10% of their $36.5 billion total in fiscal 2009, but you can see the ramp over the next 5 years, with the March quarter’s contribution 24% of AAPL’s $50.5 billion total.
It’s going to be hard for India to save the day any time soon, as demand for the iPhone SE continues to erode iPhone average selling prices (ASPs) that hit a high last quarter at $691, dropped to $645 in the March quarter and is still 3x that of average Android ASPs in Q1 of $215.
At some point soon China will stabilize, and even show signs of re-acceleration. And that will be when you buy the stock again. I’d be wary in the near term of buying into any greenshoots in India. It’s not that it wont be a huge market eventually, but I suspect sales in the country will not move the needle on their $200 plus billion annual revenue base for a few years.
My View Into the Print: AAPL is expected to print its first annual eps and sales year over year decline in fiscal 2016 in more than a decade. The company has become too reliant on one product for the lionshare of their profitability. And as evidenced by the decline in iPad sales over the last few years, and the moderate sales success (and critical failure of the Watch) the company has not been innovating, merely offering evolutionary products (iPhone SE & upcoming 7). Make no mistake, this has weighed on the stock, and is likely to continue until investors see what will be the thing to re-accelerate growth. I suspect for now bulls will point to their ramp in services, but in their fiscal Q2, despite showing 20% year over year growth in the category, their $6 billion in sales was only 12% of the whole. At this point not growing fast enough to come close to making up for the 18% yoy decline in iPhone sales in Q2, which made up 65% of sales.
Investors might look past weak fQ4 guidance in anticipation of a trough in the quarter where the new iPhone will be released with just 10 days left in the 3 month period, as consumers will be reluctant to upgrade before the new phone comes out. If the guidance speaks to a meaningful multi quarter slowdown, likely from a greater than expected decline in China then the stock will have an 8 handle quick.
As for the June quarter, it could be a mixed bag. Samsung posted solid results recently, with the stock making new highs, while some component suppliers (Skyworks Solutions on Thursday posted disappointing ones. But if we can glean anything from some options activity in late May, it looks as if the company might have accelerated some share buybacks, possibly to help manage earnings in the period (read here), while also buying shares at what was then a 52 week low, down almost 33% from its all time highs.
Oh and one more thing, while the stock’s price action from its all time highs suggest that investors are less than sanguine about the stock, it is important to note that Wall Street analysts remain overwhelmingly bullish, with 43 Buy ratings, 6 Holds and only 3 Sells. I’d be shocked if the stock were to bottom until we see sell side analysts shaken out a bit, that could be coming to a theater near you if the company were to miss and guide down again. And that could be the final piece of the sentiment puzzle that has disregarded such mundane things as valuation, balance sheet, customer satisfaction.
On Friday’s Options Action on CNBC, the implied move for earnings seems fair to downright cheap, especially for those with a directional bias. We will detail some trade ideas using options for those looking to express directional views or overlay existing positioning:
Estimates & Forecasts from Bloomberg:
-3Q EPS est. $1.39 (range $1.32-$1.47)
-3Q rev. est. $42.1b (range $41.2b-$43.7b); AAPL forecast $41b-$43b (April 26)
-3Q gross margin est. 37.9% (range 37.5%-39.5%) AAPL forecast 37.5%-38%
-4Q EPS est. $1.60 (range $1.39-$1.77); avg. est. down ~2.2% over past 4 weeks
-4Q rev. est. $45.6b (range $42.4b-$49.4b)
-4Q gross margin est. 38.4% (range 36.5%-40.0%)
-3Q iPhone unit est. 39.9m (11 ests., complied by Bloomberg)
-iPhone ASP est. ~$606 (7 ests.)
-3Q iPad unit est. 9.1m (9 ests.)
-iPad ASP est. ~$443 (5 ests.)
-3Q Mac unit est. 4.4m (9 ests.)
-3Q Watch est. 2.0m (8 ests.)
-Watch ASP ~$448 (5 ests.)