Apple Q2 Earnings Projections: One Man's Attempt At The Improbable

| About: Apple Inc. (AAPL)

Summary

Increase in Apple articles and analysis at Seeking Alpha.

Review of my Q1 projections. Oh, so close.

Is Apple aiming to go private?

As we look with anticipation towards Apple's (NASDAQ:AAPL) Q2 earnings announcement next week, I thought I'd share a few thoughts on its Q1 earnings call (transcript here on Seeking Alpha). Tim Cook, CEO, stated that the services business would double in 4 years. Taking him at his word, a quick check of the numbers suggests that Q1 2021 service revenue would be about $14.344 billion. With 16 quarters to get there, that's average growth of $448 million a quarter. This represents a 6.25% growth rate per quarter. To put things into perspective, the previous 4-year period had a 5.92% growth rate per quarter, climbing from $3.687 billion in Q1 2013 to last quarter's $7.172 billion. So, yeah, it's quite possible.

And one other thing that Tim mentioned during the Q&A session is that he remains "very bullish" on iPad. Obviously, to those of us that pour over the numbers, this is not reflected in the numbers. Even with an extra week in Q1 2017, iPad revenue dropped $1.5 billion, average sell price dropped $16.22 to $422.98 per unit (personal calculation from Apple SEC filings), and iPad units sold dropped by 3 million units when compared to Q1 2016. So this statement remains to be fulfilled at some point in the future, and I will remain vigilant to report it if and when it becomes evident.

Media "VIX"

To some, this will get a chuckle. Others will think I'm a chucklehead. Others, contrarians like myself, will find it interesting and tuck it away in a corner of our investing mind, to be drawn upon when we need additional input for our decisions.

For a few quarters, I have been conducting a rather informal gauge of Apple "frothiness" by calculating the actual numbers of Apple-related articles here on Seeking Alpha, a poor man's media "VIX" if you will. This quarter jumped dramatically. The graph below shows the average number of Apple-related articles per day on Seeking Alpha. The timeframe for these fiscal quarters is earnings release to earnings release. The Q2 2017 number is through 4/19.

Quarter

Year

APD

Q3

2015

1.447

Q4

2015

1.582

Q1

2016

1.264

Q2

2016

1.824

Q3

2016

2.198

Q4

2016

2.000

Q1

2017

1.612

Q2 QTD

2017

2.484

Well it certainly appears we haven't run out of words on our subject yet. But, why the sudden surge, a 45% jump? Are we reaching a frenzy point? Is there that much more to say? I'll let the readers be the judge. To me, it may be another indication of the fascination and compulsion we have to over-think this company like no other on the planet.

But that's not why you're here.

Apple is all about iPhones. Indeed, other revenue generators such as iPads, MACs, and Services all take a back seat to this technological phenomenon. iPhones account for a very disproportionate amount of Apple's sales. For a more complete analysis on this part of Apple's business, please see my recent article here.

So what will happen when Apple reports their Q2 results? Let's look at the numbers and see what we can learn. First, a review of where Apple left us at the end of Q1.

Review of Q1 and my Q1 projections

In the following chart, I show the guidance, my projection, and actual numbers for Apple's Q1. The guidance is from the earnings call on 10/25/16 (transcript can be found on Seeking Alpha). My projection was from my last quarterly projection article (here). Actuals are taken from Apple's 10-Q.

Attribute

Guidance

Projection

Actual

Revenue

$76-$78 billion

$77.52 billion

$78.351 billion

Gross Margin

38.0-38.5%

38.6%

38.51%

Operating Exp.

$6.9-$7.0 billion

$6.817 billion

$6.915 billion

Other Income

$400 million

$400 million

$821 million

Tax Rate

26.0%

26.0%

26.01%

Share count

No guidance

5,320,611,000

5,327,995,000

Earnings Per share

No guidance

$3.34 per share diluted

$3.36 per share diluted

Despite my rather large $831 million miss on revenue, I got within a percentage point of the EPS. Not bad considering consensus of the pros put EPS over 4% lower. Not even Apple came close on the Other income, and my share count was certainly close at just 0.15% off. But that was then. Moving on.

Q2 Apple Guidance

In the following table is the pertinent numbers that Apple provided guidance on during the Q1 earnings call.

Attribute

Q2 Guidance

Revenue

$51.5-53.5 billion

Gross Margin

38.0-39.0%

Operating Exp.

$6.5-$6.6 billion

Other Income

$400 million

Tax Rate

26.0%

Share count

No guidance

Earnings Per share

No guidance

Q2 Guidance Analysis and Projections

Revenue

First, the obvious. Apple is guiding Q2 2017 to be just slightly above the year-ago quarter; Q2 2016. Q2 2016 came in at $50.557 billion. This has the potential to be the largest Q1 to Q2 drop in Apple's history if they come in close to the low end of guidance. As Luca Maestri pointed out in last quarter's earnings call, Q2 will be aided by a $1.2 billion headwind from foreign exchange. This is already built into this quarter's guidance numbers. And, the trend is for larger and larger drops as shown in the chart below (source for revenue data: Apple SEC filings)

Year

Q1 (Billions)

Q2 (Billions)

Drop

% Drop

2009

$10.167

$ 8.163

$ 2.004

19.71%

2010

$15.683

$13.499

$ 2.184

13.93%

2011

$26.741

$24.700

$ 2.041

7.63%

2012

$46.333

$39.186

$ 7.147

15.43%

2013

$54.512

$43.603

$10.909

20.01%

2014

$57.594

$45.646

$11.948

20.75%

2015

$74.599

$58.010

$16.589

22.24%

2016

$75.872

$50.557

$25.315

33.37%

2017

$78.351

???????

2017 Q2 Guidance

$51.5-53.5

$24.851-$26.851

31.72%-34.27%

Additionally, Q2 revenue has been relatively resilient in beating high guidance in 3 out of the last 4 years. Of course, it is widely known to my readers that Apple never missed to the low side since reverting back to a revenue range guidance format in Q2 of 2013. The trend for the last year is tugging in the right direction at 2.6% over low guidance. This would put revenue at $52.851 billion and a 32.5% drop from Q1. This feels right and looks good to me from many angles. This will be my Q2 estimate for revenue.

Gross Margin

As mentioned in the section above, during last quarter's earnings call, Luca Maestri mentioned that Q2 had headwinds brought about by favorable foreign exchange rates. This applies to gross margin as well with an expected bonus of 80 basis points. This probably explains the reversion to a wider range of guidance for Q2 of 38.0 to 39.0%.

The average gross margin over the last 16 quarters has been 38.76%. Factoring out the extraordinary 80 basis point headwind would put normal gross margin just under 38.0%, about where it was for Q3 and Q4 of 2016. However, Q2 has average 39.25% over the same time frame and 13 out of the last 14 quarters have beaten high guidance. Given this history and a built-in headwind, I am moving forward with a projection of 39.25%.

Expenses

Since reverting to providing ranges for some guidance items in 2013, Apple has never exceeded the high-end guidance number for expenses. The low end of the range is where the action is, with nine of those sixteen quarters coming in below guidance. The 16 quarter average comes in at 100.019% of low guidance. Q2 averages just under low guidance at 99.88% of low guidance. With two averages nearly coinciding, I'm going to go any further and go with the low guidance estimate number of $6.5 billion for expenses.

Other Income & Expense

Q1 was a shocker on this parameter. It was more than double Apple's guidance at $821 million. In fact, I had to revisit this to more fully try and understand what happened here. Buried in the financial notes to the consolidated financial statements on every 10-Q and 10-K is a section delineating this P&L statement item. The three components of this are "Interest and dividend Income," "Interest Expense," and what seems to be a redundant "Other Income/Expense, net." This last category is what caused the Q1 jump in this parameter. Q1's Other Income/Expense, net amount was $122 million in INCOME. In fifteen previous quarters, this number has been negative, averaging $192 million in expense. Quite a turnaround, and there is no explanation as to what is included in this amount. The last time this number showed as income was back in Q1 of 2013 with a net income of $41 million.

So for Q2, Apple has guided a number of $400 million. In my past couple projections, I took Apple's guidance as close enough. For Q2, I'm changing that up. Due partially because of the 14 week Q1, I think interest and dividend income will increase only $10-$15 million. I also believe interest expense will continue its uphill climb, settling in around $585 million. and I believe the Q1 Other income will be a positive blip, but this sub-parameter will revert to the expense side. I'm going to go with the 16 quarter average of $185 million. This gives us an OI&E projection of $467 million.

Tax Rate

Consistency. That's what Apple's tax team provides us. Quarter after quarter, the guidance for this parameter is within a couple of percentage points north or south of the actual. Looking at a 16 quarter average, the numbers are even more impressive. The average guidance for this period is 26.078%. The actual tax rate average for these last sixteen quarters is 26.080%. For this stellar track record of accuracy, I will utilize Apple's guidance of 26.0% as my projection for tax rate.

Share Count

Apple continues to strengthen its bottom line through continued massive spending on its share. The chart below shows the number of shares (weighted average diluted shares) used to calculate earnings per share. The timeframe is since the 7:1 split.

Qtr

Year

Date

Diluted shares

3

2014

6/28/2014

6,051,711,000

4

2014

9/27/2014

5,963,984,255

1

2015

12/27/14

5,881,803,000

2

2015

3/28/15

5,834,858,000

3

2015

6/27/15

5,773,099,000

4

2015

9/26/15

5,675,179,388

1

2016

12/26/15

5,594,127,000

2

2016

3/26/16

5,540,886,000

3

2016

6/25/16

5,472,781,000

4

2016

9/24/16

5,396,157,464

1

2017

12/31/16

5,327,995,000

In terms of slope, this equates to a 1.087% drop each quarter. Applying that number to estimate Q2 gives us a projected share count of 5,270,070,657 - a drop of another 57,924,343 shares. I'm comfortable with this projection due to the consistency of the past history and the commitment by management to continue with these programs. With consistent slope like this, Apple is probably less than 23 years from being a private company.

Surprise

The average surprise of actual earnings versus earnings calculated from guidance over the last 8 years is 21.2% per quarter. Q2 has averaged an even higher 21.7%. But narrow the timeframe down to just 4 years and the average drops to just 4.0%. The last 5 quarters averaged just 0.4%. Surprise has nearly gone away looking at these stats. Last quarter's surprise (Q1) came in at 5.3%, but, then, for the last nine Q1s, there has always been a positive surprise. Q2 is different with only half of the last four Q2 numbers being positive. Because of this recent split, I am going to run with the very low 5-quarter average of just 0.4% surprise. Plugging that number in, the EPS calculations change less than a penny per share and do not change the rounded numbers at all.

The following chart summarizes my predictions against Apple guidance. For share count, where Apple does not provide any guidance, I used my projected number to determine the projected range for its guidance. For general information purposes, the current "pro" consensus for Q2 earnings as of 4/19 is $2.0 with the high estimated EPS at $2.14 and the low coming in at $1.91.

Parameter

AAPL Guidance

Projection

Revenue

$51.5-53.5 billion

$52.851 billion

Gross Margin

38.0-39.0%

39.25%

Operating Expenses

$6.5-6.6 billion

$6.5 billion

Other Income/Expense

$400 million

$467 million

Tax Rate

26.0%

26.0%

Share count

No guidance

5,270,070,657

Calculated EPS

$1.89-$2.07

$2.07

With Surprise

$1.89-$2.07

$2.07

Stock Price Reaction

With the stock price "languishing" in the low $140s for over a month now, I wanted to see if there was any correlation between stock price and earnings surprises over Apple's recent history. Going back over 8 years, 33 quarters, the average price change 1 week after the earnings announcement is an increase of 1.89%. One month later, 3.02% higher.

However, over the last 5 quarters, the one-week average is actually negative (-1.77%). And, thanks to a tremendous gain last quarter, the one-month average over the last five quarters is 1.39%.

Over the Tim Cook era, the one-week gain after earnings announcement has averaged 1.20%. The one-month average percolates higher to 4.4%.

Other things that caught my eye in this analysis: This last run-up of 8%+ within one week and 15.2% after one month from the Q1 earnings release was extraordinary when compared to the averages. However, three out of the last five quarters (and five of the last eight) have been in negative territory after one month. How likely is another run-up after this next earnings announcement?

My thoughts... Based on my earnings expectations from this article and not knowing whether or not the Q1 run has got any legs left in it, I would be hesitant to think that the year-end levels, with an approximate P/E of 14.5, would return. That would put the stock back in the low $120s. Instead, I think an initial lower level down to a P/E of 16 and alignment with the negativity of a solid but not earth-shattering quarter would put the one week price in the mid $130s before recovering with additional Apple marketing announcements. I still like the covered call options possibilities and a dividend increase should be in the cards for this announcement.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: From time to time, I/we utilize Apple as part of a covered call rotation. I do not expect to have a position this month.

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Tagged: , Personal Computers, Earnings
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