Apple: Covid Boom Ultimately Ends In Tears

Jan. 28, 2022 5:46 AM ETApple Inc. (AAPL)363 Comments

Summary

  • Apple reported another magical quarter with big revenue and EPS beats.
  • The company is guiding to further growth deceleration in the March quarter.
  • The stock is priced for perfection at 28x forward EPS targets while growth is headed towards stall speeds.
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Construction nails piercing a green apple

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As investors have been warned and seen with other tech stocks, the COVID-19 boom eventually leads to pain. Apple (NASDAQ:AAPL) was one of the biggest beneficiaries of the tech pull forward in the last year and growth rates are now decelerating. My investment thesis remains Bearish on the stock as guidance around FQ2'22 results confirm the gravy days are over for the company.

Normalized Growth

Apple has spent the last year trading at 30x forward earrings as investors got too used to the fast growth pulled forward by the WFH environment due to COVID-19 lockdowns. The reality is that revenues have historically grown far below 10% annually with several periods in the last decade where the tech giant reported negative YoY growth.

Chart
Data by YCharts

For this reason, Apple analysts were forecasting FQ1'22 revenue growth of just 6.4% followed by only slightly positive revenues for the March quarter. The company actually reported revenue growth of 11.2% in the December quarter to reach $124 billion.

The quarterly results were fantastic for a company the size of Apple. The problem is that the growth rate of 11% in the quarter is substantially below the nearly 29% YoY growth rate in the prior quarter.

Apple still isn't providing full revenue guidance in what remains a negative sign for the business. The tech giant still suggests numbers are showing irrational revenue pull forwards, or the company would be able to provide numbers for the next quarter in a more traditional environment. The comments surrounding the FQ2'22 numbers all suggest revenue growth decelerates from the December quarter with foreign exchange providing a 300 basis point headwind in comparison to the prior quarter.

Also, the company had another fantastic quarter from selling more of existing products. As highlighted in previous research, the problems with Apple are taking the next step with new products such as an AV/VR device and autonomous vehicles. The company will need to spend substantially more as a percentage of revenue to compete with the other tech giants in these areas.

The December quarter saw all categories outside of the iPad beat analyst estimates and grow over the prior year period. Even the weakness with the iPad, with sales down 14% YoY, was potentially due to Apple taking parts from this product to feed the growth of the iPhone:

  • iPhone revenue: $71.63 billion vs. $68.34 billion estimated, up 9% year-over-year
  • Services revenue: $19.52 billion vs. $18.61 billion estimated, up 24% year-over-year
  • Other Products revenue: $14.70 billion vs. $14.59 billion estimated, up 13% year-over-year
  • Mac revenue: $10.85 billion vs. $9.52 billion estimated, up 25% year-over-year
  • iPad revenue: $7.25 billion vs. $8.18 billion estimated, down 14% year-over-year
  • Gross margin: 43.8% vs. 41.7% estimated

Apple saw gross margins soar to 43.8% while operating expenses are starting to grow at accelerating rates. The company grew key R&D expenses by 22%, or $1.14 billion over the levels from FQ1'21.

Apple Operating Expense table

Apple FQ1'22 earnings release

Even the SG&A expenses grew at a 15% clip, far outpacing the revenue growth rate. The company will face some pain to operating margins in future quarters with these growth rates in operating expenses while revenue growth stalls. Such margin pressure could offset the small benefits from a large capital return plan.

Apple spent $20.5 billion on share buybacks during the quarter, but the large spending doesn't go very far when the market cap reaches $3 trillion. The tech giant has seen the net cash balance slip to $66 billion in the December quarter, as the company continues to head towards a net neutral cash position.

The net payout yield is an indication of stock valuation and the yield has never been lower since Apple started repurchasing shares. The current 3.8% yield is an indication of the limited value Apple sees in the stock with capital returns mostly flat with prior years and the nature of how the tech giant has the lowest net cash position since starting share buybacks.

Chart
Data by YCharts

A 2% to 3% reduction in share counts won't move the needle much going forward. Apple would be far better building the cash position back up when the stock is trading at a premium valuation versus spending so aggressively repurchasing the expensive stock.

Priced For Past Perfection

Apple is up only a few dollars after reporting an outstanding quarter because the stock is priced for the perfect results of the past year. Heading into quarterly results, Apple was trading at nearly 28x forward EPS targets.

Chart
Data by YCharts

Even in a blowout quarter, Apple only grew EPS by 25%. The growth rates will only fall from these levels going forward as revenues slow and operating expenses ramp.

The stock is priced for the tech giant growing revenues at a level unsustainable considering the company has a history of product sales running in cycles. At the same time, Apple is starting to show signs of needing to boost R&D and likely CapEx leading to expense growth far outstripping revenue growth.

Takeaway

The key investor takeaway is that Apple is priced for perfection, yet the market knows results are heading towards flat growth. The logical conclusion is for the tech giant's stock to inevitably fall to levels more in line with greatly reduced growth rates in future periods. The COVID-19 boom of the last year ultimately ends in tears for shareholders holding on too long.

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This article was written by

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Stone Fox Capital Advisors, LLC is a registered investment advisor founded in 2010. Mark Holder graduated from the University of Tulsa with a double major in accounting & finance. Mark has his Series 65 and is also a CPA.


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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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