Apple Earnings: Lack Of Bad News Is Great News
Summary
- Apple's fiscal 2Q20 was not a clean quarter, but I was pleased by resilience in the service segment and strong cash flow.
- Apple seems well positioned to weather the current health and economic crisis and to rebound once the macro-level forces are more favorable.
- The investment thesis remains intact, as Apple pushes forward on its transition to a more stable, often recurring-revenue business model.
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Despite all the challenges, Apple (NASDAQ:AAPL) managed to deliver a solid all-around beat for fiscal 2Q20. Revenues of $58.3 billion increased minimally YOY, when consensus estimates pointed at a rather sharp 6% contraction. EPS of $2.55 also impressed, topping consensus by nearly 30 cents. I estimate, however, that below-the-op line items (e.g. a more favorable tax rate) accounted for about one-fourth of the earnings surprise.
At least so far in 2020, Apple has been managing the COVID-related issues well. This is not to say, however, that the third fiscal quarter, traditionally a slower period for device sales, will be a walk in the park for the Cupertino-based company.
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A quick glance at the results
In my earnings preview, I listed the three items of discussion that I considered most important: (1) iPhone sales dynamics, (2) the impact of the crisis on service revenues, and (3) capital allocation plans.
On the first item above, the smartphone business certainly did not do much to boost financial performance. Sure, sales topped expectations by an inch. But the nearly 7% YOY decline suggests that supply chain disruptions, store closures, and a decline in demand for high-priced devices during times of economic distress served as meaningful headwinds.
The better news is that the management team reported a healthy channel inventory exiting the quarter. Also, production and the supply chain seem to have returned to normal, while the reopening of global economies should support Apple store sales going forward - especially in Greater China, where revenues dropped 7.5% YOY. The new iPhone SE has been reported to have strong demand, although April numbers were (unsurprisingly) not provided.
Source: DM Martins Research, using data from company reports
On the second topic of discussion, I was pleasantly surprised to see service revenues climb almost undisturbed. The 17% growth rate was very much in line with last quarter's metric, despite the segment having gained quite a bit of scale over the past few years. Apple is well ahead of its plan of doubling 2016 service revenues by 2020 (see chart below), with paid subscriptions up over 100 million YOY to more than half a billion today. This bodes very well for my investment thesis, which leans heavily on the business transition from one-off device sales to a more stable, often recurring-revenue model.
Lastly, Apple's balance sheet remained healthy, to say the least. Cash flow from operations for the quarter was $2.2 billion higher YOY (up nearly 20%) despite all the challenges, which I find impressive. As a result, Apple maintained its capital allocation plans, increasing dividend payments by 6%. The company also announced $50 billion in extra share repurchases when most other companies have been halting their buyback efforts. This number, however, may have been a bit lower than what some analysts were expecting.
Source: DM Martins Research, using data from multiple company reports
No change to the investment thesis
Apple was unable to dodge the COVID-19 bullet in the second fiscal quarter, but analysts and investors certainly did not expect them to. The two percentage point pressure to share price in after-hours trading was probably better reflective of profit-taking moves (the stock had been up about 20% for the month) and less indicative of unforeseen troubles ahead.
In the end, I believe that lack of substantially negative news on earnings day can be considered good news. Apple appears to be well positioned to weather the current health and economic crisis (e.g. strong balance sheet, solid cash flow), but also to rebound once the macro-level forces are more favorable.
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This article was written by
Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.
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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.
He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.
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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.
DM Martins Research also manages a small team of writers and editors who publish content on several TheStreet.com channels, including Apple Maven (thestreet.com/apple) and Wall Street Memes (thestreet.com/memestocks).
Disclosure: I am/we are long AAPL. 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.