Apple Earnings Review: Not Too Ugly Under The Hood

Summary

• Apple's miss on revenues and EPS in fiscal Q1 was a first in the past 20 quarters, if not longer.
• But under the hood, the fundamentals of the business look strong. FX masked growth across the board, while margins look very good.
• I feel good holding Apple stock at current levels for an implied 21% upside to all-time highs.
• Looking for a helping hand in the market? Members of EPB Macro Research get exclusive ideas and guidance to navigate any climate. Learn More »

Scott Olson

Apple Inc. (NASDAQ:AAPL) reported earnings on February 2, and the headline numbers must have scared many investors. The top- and bottom-line miss was rare: something like it had not happened in the previous 20 quarters, if not longer. AAPL stock dropped by as much as 5% in after-hours trading.

But the more I looked at the numbers, in the context of what the management team discussed during the earnings call, the more I realized that fiscal Q1 was far from disastrous. Traders seem to have taken notice, too, as Apple partially recovered from the after-hours slump.

Apple's Fiscal Q1: Not Disastrous

The charts below depict YOY revenue change by business and geographic segments. Other than the iPad, which benefited greatly from the timing of the launch of the Pro and 10th generation models, probably nothing else looked very pretty to AAPL investors.

DM Martins Research

But contrary to what I had suggested in my earnings preview, FX was nearly as bad a headwind as Apple had warned about three months ago, despite the U.S. dollar having weakened quite a bit in calendar Q4. To my surprise, 800 basis points of currency drag means that Apple would have grown revenues by about 3% this quarter (maybe flat, if we adjust for the extra week in the quarter), despite massively disruptive supply chain constraints that even Tim Cook seems to believe are largely behind us. What this means is that Apple's underlying business seems to be in much better shape than the company's P&L suggests on the surface.

The other major area of concern for me was the performance of the high-margin Services segment, responsible for over two-fifths of Apple's operating profits in fiscal 2022. While I feared that growth could converge to zero this quarter, a 6% YOY increase coupled with 700 bps of currency headwinds suggest that Services would have climbed 13% on top of last year's impressive 24% growth rate, all of it despite evidence of fatigue in consumer spending hurting most other companies around the world.

The cherry on the cake was guidance for fiscal Q2. On the revenue side, the two most important business segments, iPhone and Services, are expected to improve. FX headwinds are moderating. The mic-drop was gross margin guidance of 44.0% at the midpoint of the range, representing impressive expansion of 70 basis points YOY despite: (1) currency challenges; and (2) macroeconomic softness that, to other companies, could translate into lower ASP (average selling prices).

I plugged the guided numbers into my model and, assuming current revenue consensus of $97.8 billion (which was not guided by CFO Luca Maestri), I estimate that Apple effectively guided for EPS upside to consensus of 7 cents per share. See below.

Apple's Fiscal Q2 Table: Guidance vs. Consensus

AAPL: Own The Best House

The title of my earnings preview was "best house, bad neighborhood." On its earnings day, I think that Apple reinforced my idea that the Cupertino company is a stand-out executor in a tech sector that seems to be walking on eggshells - hence the massive layoff plans announced recently.

To be clear, a global recession in 2023, if one materializes, is unlikely to spare even Apple. But I am thoroughly satisfied with the company's recent results and short-term guidance, given the circumstances and despite the shock factor of this Thursday's all-around earnings miss.

Data by YCharts

To me, the only potential yellow flag is valuations that remain elevated (see above), especially after AAPL's 20% YTD rally. Per my calculations, the median P/E of mega-cap companies with a similar growth and stock risk profile, as Apple is currently 17.2x, a whopping 7.5 turns lower than Apple's 24.7x.

But as much as hardcore value investors may disagree with me, I think that owning quality requires one to pay a premium. I feel good holding Apple stock at current levels for an implied 21% upside to all-time highs.

Disclosure: I/we have a beneficial long position in the shares of AAPL either through stock ownership, options, or other derivatives. 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.