Apple Earnings Preview: Will China Deliver Again?

Jul.21.14 | About: Apple Inc. (AAPL)

Summary

Apple Earnings this week will update investors on a host of issues for the company.

The Chinese market remains a strong focus.

Positive sentiment and momentum point to continued success for Apple's stock.

The last time we checked in on Apple (NASDAQ:AAPL) pre-Q2 earnings, the stock was in a tight holding pattern and was looking for momentum to breakout higher. In our China Delivers recap we noted the strong evidence that China was somewhat unexpectedly helping propel Apple's earnings to impress the market and lead to an 8% bump.

Since the article's publication, the stock has risen from a stock-split-adjusted $75/share to $94/share as of July 18th, 2014. Simply, the prospects for Apple have brightened, and though some challenges remain, the company is poised to continue reaping the benefits of the Chinese market.

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Moving Averages as Indicators of Momentum

A prominent feature of Apple's price action has been the positive signals on the 50-day and 200-day Moving Averages. As a long-term focused investor, we keep the 200-day MA in our sights, as day-to-day fluctuation is evened out. We believe MAs can be useful metrics in gauging a stock's momentum and trend. MAs filter out noise and smooth stock price action (like where tragic events have effects on the market) and for Apple, the stock is well above both 50- and 200-day MAs. This is a stark change from the last earnings report, where both MAs and the stock price itself were all very close, in the $74 dollar range, with the stock trading even below the 50-day MAs at the time.

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In fact, a bullish crossover occurred in May when the 100-day is broken out against the 50-day MA; the shorter term MA crossed over the longer term MA and continued higher. The stock experiences broad gains since the earnings report, and the MAs confirm the momentum.

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We insist keeping these lagging indicators in mind when mapping out the possible trajectory of a stock, as events like earnings reports and geopolitical turmoil can often shake the long-term focus of investors.

China and the Asian Market

As catalysts for iPhone sales growth, China and countries like Japan clocked in promising revenue growth year-over-year, with China growing 13% and Japan's growth an even more impressive 26%. As we stated, the "traction" of the iPhone in China was ahead of expectations, with sales growing 28% there. The adoption of Apple's products in a country with millions of potential customers obviously serves to improve Apple's revenue growth. Investors should listen to how Japan and China are continuing to contribute to Apple's growth, and weigh any warning signs carefully.

Challenges: Competition and Point-of-Sales

Some challenges remain for Apple products in China, however. On the latest earnings call, CEO Tim Cook suggested there was lot of runway ahead of Apple's points of sales for the iPhone in China. At 40,000, Cook commented that "we're not nearly where we need to be on the rest of our product line and even the 40,000 is a low number considering the broad landmass and the number of folks in China." Investors should keep an eye on any improvement here for Apple, as broader penetration through increased access to Chinese consumers would bode well for sales.

Xiaomi

It's difficult to grasp a complete understanding of the effect that Chinese smartphone maker Xiaomi has had on Apple and Samsung (OTC:SSNLF) sales in the country. Aggressively priced, Xiaomi is on pace to sell over 50 million handsets this year, after upping its target from 30 million recently. Although Apple's presence in China and the recent China Mobile (NYSE:CHL) deal have helped it grow considerably in China, the pace of this growth will likely always be at risk with Xiaomi and other low-cost handset makers operating successfully there.

Future of the Stock

Share Repurchase and Dividend

The last time the company reported, investors were rewarded with good news on the share repurchase program and the dividend. Along with the 7-for-1 split, Apple Board of Directors announced shareholder friendly news: an increase in the share buyback, and an 8% increase in the dividend. Endless debate on whether Apple is a growth or value stock continues, but the bottom line is that shareholders are getting more handsomely rewarded with an increased dividend. And of course, buyers are given whatever degree of confidence one ascribes to the fact that the company considers itself undervalued at the current price and is seeking to buy more shares while it can. Investors like Carl Icahn may have helped move the hand of the executives at Apple, as the notoriously high cash pile has sat largely idle. We consider share buybacks to be a largely positive reflection on a company's management and their perspective on stock price.

Analysts Take and Estimize

Revisions to EPS estimates over the last few weeks have been to the upside. The chart below from Yahoo Finance explains the trend:

Hype over higher iPhone sales and other positive catalysts have led to 19 upward EPS revisions, to 1 downward revision, over the last 30 days. That is a very sizeable proportion of revisions pointing to higher earnings than previously thought. Indeed, upward full year EPS revisions accounted for 10 of the 11 revisions in the last month. Sentiment among analysts is positive.

Finally, we noticed an interesting trend over at Estimize, an earnings forecast community that crowdsources estimates from thousands of hedge funds, banks, and independent analysts. Over the last 8 earnings reports, the Estimize Consensus was higher on EPS estimates than both the Wall Street Consensus and the actual reported results for 5 quarters in a row ending Q3' 13. Over the last 3, however, Estimize Consensus was higher only than the Wall Street consensus, and was actually lower than the actual reported results.

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This quarter, Estimize Consensus of 1.29 EPS sits 7 cents higher than the Wall Street Consensus of 1.22 EPS. What if the Estimize Consensus is too low for the 4th quarter in a row? Apple's results would have to come in at 1.30, which would be a solid 8 cent beat over the WS consensus.

Takeaway

Positive sentiment surrounding the stock, characterized by EPS revisions towards the upside may be creating expectations that Apple cannot meet. But with the Moving Averages also pointing towards more positive momentum going forward, along with shareholder friendly actions like higher dividends and buybacks, we expect Apple to have a strong quarter and finish out the year with impressive results.

Disclosure: The author is long AAPL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.