13 Apr Apple (AAPL)
With Apple reporting second-quarter earnings at the end of April, and with a share price heavily impacted by society’s global shutdown, we thought it might be time to take another look at the iCompany and where it currently sits value-wise. If you’ve been at Capital 19 for any length of time, and read the Catch-Up or any of our various stock reports, you’ll know that Apple has been our favourite stock for well over a decade.
It has been a star performer over that period, and a much-loved ten-bagger since the end of the GFC. Importantly, there have been many moments over those last ten years where the share price has fallen back and provided great buying opportunities. In 2012 the company was on the nose with Wall St for one illogical reason or another and a 30% pullback provided a chance to top up our holdings. The same thing happened again in 2015, and then again at the end of 2018 when all of Wall St was hit, especially the tech companies, and we had another 30% pullback.
Just two and a bit years on and the coronavirus has provided us with another discount. But should we be jumping in again just yet or could there be better opportunities in the near future?
There is no doubt that like most global companies the covid19 pandemic will hit Apple hard. Their production lines are heavily invested in China, which also happens to be its second biggest market. It’s US retail outlets are closed, as they are across Europe and the rest of the globe, impacting sales and increasing reliance on website traffic. And consumers the world over have lost their jobs and with them their spending power.
The next two quarterly announcements will be a horror show, and the fallout will no doubt extend into the few following quarters as well. Apple pulled back its guidance for its upcoming results, set to be announced on the 30th April. It’s expected revenue will be down around 15% but the real number is anyone’s guess. What we do know is that the market is expecting bad numbers – as it is with the rest of the market. It will be interesting to see how much is currently baked into the share price which is down around 19% from its highs at the time of writing.
The shining light in what will be an otherwise tough result will be Apple’s Services division. We have been banging on for years about how Apple was in the process of transitioning from a hardware company to a services company, and at the very least moving away from its reliance on the iPhone as its major source of revenue.
As a quick recap, the service division includes Apple’s iCloud service, its Apple music streaming product, the iTunes store, Apple news, Apple Pay, the newly released Apple Tv+ (hasn’t that arrived just in time), and Apple arcade (which my kids are currently addicted to – and is effectively their new substitute teacher while school is shut down). It’s mostly subscription-based, providing Apple with an ongoing stream of revenue that is locked in tight.
Right now is when this move will be paying big dividends. In the final quarter of 2019 Apple’s services business pulled in a record $12.72 billion in revenue, a year on year increase of 17%. It was also up 18% in the previous quarter. It’s an unstoppable beast. The coronavirus certainly won’t have an impact. If anything subscriptions will likely be boosted thanks to a consumer market stuck in the house and looking for entertainment.
In the last quarter, Apple revealed the margins for its services sector for the first time, and it was an impressive 62.8%. Compare that to the company’s overall gross margin which is 38% and you see why it will be a crucial business going forward. As Apple iPhone products reach a saturation point, the service division will be relied upon to do the heavy lifting.
Services is also an integral aspect of the Apple ecosystem. A customer buys an iPhone or iPad, signs up to Apple Music or Apple news or any of the other Apple services, and is then more likely to buy another Apple device when the time comes because it’s much easier to use Apple services on an Apple device. Device sales increase service sales, which in turn increases device sales which increases services, and so on and so forth. It’s a lovely money making cycle. Once you’re in it it’s extremely difficult to extract yourself.
Apple’s balance sheet is also the best in the business. It’s got a lazy $207.06 billion in cash on hand. Not only does this make it untouchable during an economic downturn but it gives it an advantage not many other companies can exploit. I have no doubt it will be using this time to sift through the financial carnage created by covid19 to find a few cheap buys of its own. It’s what Apple does best – taking an existing product or service, giving it the Apple makeover, then rolling it up within its own bundle of services.
All of this makes Apple a great buy going forward. At the moment it’s at a 20% discount, and in the next few months, as the next couple of earnings reports are released, you may even be able to get it even cheaper. A good buying strategy would be to pick up a little now and sit on the sidelines for a while. Then each time the market dips over the next few months, as it no doubt will, pick up a little more each time.
We all know that this current drama will pass. Apple will be back to its best as soon as the economy starts firing again. Owning Apple is a no brainer, and buying it at a discount is even better.