Apple Inc
3rd Quarter Results
On the 17th May 2023, we wrote a note on Apple which can be read here
In the note, we outlined the incredible success of the company since the introduction of the iPod in 2001 and the iPhone in 2007. The iPhone accounted for about 50% of total revenues though this number has been falling gradually thanks to the rapid growth of the highly profitable services segment which in Q2 accounted for about 22% of total revenues.
Our conclusion at the end of the note was as follows:
“At an earnings yield of 2.9% and a Free Cash Flow Yield of 2.5%, the (Apple) shares do not feel like good value, especially in a world in which short-term interest rates have jumped to 5%.
It was much better in 2016 when interest rates were 0.5% and FCF yield was over 6%. Warren Buffet probably invested a significant amount at that time when a temporary sell off, after poor sales numbers in China, saw an FCF yield close to 10%.
This is a difficult call. We recommend investing 25%-30% of our ideal final allocation now and then wait and watch for a sell off and/or better valuation. If interest rates fall to ~ 3%-4%, a FCF yield of of 4% to 5% would be like an attractive point to invest more.”
The shares have only risen 1.7% in the last three months greatly underperforming the market.
The company reported its latest quarterly results on the 3rd August 2023 and these provide a timely opportunity to again look at the company.
Bloomberg reported the results as follows:
Revenue: $81.80 billion versus $81.55 billion expected ($82.96 billion in Q3 2022)
Adj. EPS: $1.26 versus $1.20 expected ($1.20 in Q3 2022)
iPhone revenue: $39.67 billion, versus $39.79 billion expected ($40.67 billion in Q3 2022)
Services revenue: $21.21 billion versus $20.77 billion expected ($19.60 billion in Q3 2022)
Mac revenue: $6.84 billion versus $6.37 billion expected ($7.38 billion in Q3 2022)
iPad revenue: $5.79 billion, versus $6.33 billion expected ($7.22 billion in Q3 2022)
Wearables revenue: $8.28 billion versus $8.38 billion expected ($8.08 billion in Q3 2022)
These were an unremarkable set of results in part due to some headwinds.
One notable headwind as the high demand during Covid19 /WFH era as a lot of equipment was purchased at the time and much demand was brought forward. Apple has found it difficult to achieve high growth since then.
Another headwind was 4% points due to adverse foreign exchange movements. This would mean that a 6% growth in constant currency terms would be reduced to a 2% growth in US$ terms.
iPhone revenue came in at $39.7bn for the quarter, down 2% from the year ago quarter's record performance. iPhone share fell below 50% to 48.5%
Mac. We recorded $6.8bn in revenue, down 7% year-over-year.
iPad revenue was $5.8bn for the June quarter, down 20% year-over-year.
Services was the bright spot and grew 8% to US$ 21.2bn (26% of total revenues)
Gross margin was 44.5%, a record level for the June quarter and up 20 basis points sequentially, driven by cost savings and favorable mix shift towards Services, partially offset by a seasonal loss of leverage.
Product gross margin was 35.4%, down 130 basis points from last quarter. Services gross margin was 70.5%. As services grow more strongly- overall average margin will grow.
The company duly focused on the two positive factors in the results - the growth in Services and growth in iPhone sales in new emerging markets like India (new for Apple). However, the latter is from a low base and demand in the core American market is challenged.
Outlook.
“We expect iPhone and Services year-over-year performance to accelerate from the June quarter.”
“We expect the revenue for both Mac and iPad to decline by double digits year-over-year due to difficult compares, particularly on the Mac.”
“We expect gross margin to be between 44% and 45%.”
“We expect Operating Expenditure to be between $13.5 billion and $13.7 billion.”
Highlights from the Conference Call
iPhones.
We continued to see strong results in emerging markets, driven by robust sales of iPhone with June quarter total revenue records in India, Indonesia, Mexico, the Philippines, Poland, Saudi Arabia, Turkey and the UAE. We set June quarter records in a number of other countries as well, including France, the Netherlands and Austria.”
“…it's a challenging smartphone market in the U.S. currently.”"
Services Growth.
We had all-time records in iCloud, in video, in AppleCare, in Payments and June quarter records in App Store, Advertising and Apple Music. We saw improvement in all our Services categories.
… our installed base of over 2 billion active devices continues to grow at a nice pace and establishes a solid foundation for the future expansion of our ecosystem. Second, we see increased customer engagement with our services. Both our transacting accounts and paid accounts grew double digits year-over-year, each reaching a new all-time high. Third, our paid subscriptions showed strong growth.
This past quarter, we reached an important milestone and passed 1 billion paid subscriptions across the services on our platform, up 150 million during the last 12 months and nearly double the number of paid subscriptions we had only 3 years ago.
Our installed base continues to grow, so we've got a larger pool of customers, to the fact that our customers are more engaged as we have more transacting accounts and paid accounts on the ecosystem.
The biggest opportunity is that we know that there's a lot of customers that we have that are very familiar with our ecosystem. They are engaged in the ecosystem. But still today, they're using only the portion of the ecosystem that is free.And so we think that by offering better content and more content over time, we're going to be able to attract more of them as paid customers.”
AI.
Apple talks less about AI than other tech companies as they are primarily a product company.
“We view AI and machine learning as core fundamental technologies that are integral to virtually every product that we build. …(at)… WWDC in June, we announced some features that will be coming in iOS 17 this fall, like Personal Voice and Live Voicemail. Previously, we had announced lifesaving features like fall detection and crash detection and ECG. None of these features that I just mentioned and many, many more would be possible without AI and machine learning.
We've been doing research across a wide range of AI technologies, including generative AI for years. We're going to continue investing and innovating and responsibly advancing our products with these technologies with the goal of enriching people's lives.”
Lower growth in Operating Expenditures and R&D.
“it's been about 3 quarters now where we've seen Operating Expenditure either grow below historical seasonality or come in below your expectations. …the first time we've seen R&D grow less than 10% year-over-year since fiscal 2Q 2007.”
Summary
This was subdued set of results due to weak demand (esp for iPhones in North America) and currency headwinds.
Macs and iPads are seeing falling sales due to tough comparisons and poor macro-economic conditions and this is likely to continue in the next few quarters
Services continue to grow impressively and now account for 25% of total revenue. This has boosted Gross Margins to record highs and should continue to improve as services will grow faster than products.
Conclusions
The company is finding is difficult to grow Product demand in meaningful ways. Services demand is encouraging but they still only account for 25% of revenue.
The stock is currently trading at 27 times forward earnings. This does not look expensive for a company that has around 30% operating margins and double digit revenue and profit growth.
However, there is currently no trigger to move the price higher in the short-term. We will wait for one or two quarters to see if products/devices demand picks up strongly and also whether Services continue to make strong progress before we add to our position.