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Apple's Allure Not in Decline

Brian Colello, CPA

Brian Colello: Apple reported disappointing fiscal [second-quarter] results last night and gave a [third-quarter] forecast that was even a little bit worse than what we were previously expecting; they missed on virtually every metric. But that said, we still didn't see a lot that changes our long-term view on the company. We maintained our $133 fair value estimate. We still think the company's competitive position is very strong. We think the headwinds that they're facing are currency-related, macroeconomic-related, to some extent less excitement about the iPhone 6s than in prior years. But with the stock trading at about $97 today, it looks as if Apple's trading... The stock price implies as if Apple is in secular decline and we wouldn't go that far. We still think there's a lot of customer loyalty there. We still see a very strong competitive position for Apple, and we do like the long-term picture.

We knew going into the quarter that Apple's iPhone sales were going to be down from the year-ago period. So in those terms, sales of 51 million units were only slightly worse than expected--not too bad. China was down as expected, there's certainly some macroeconomic issues there. Pricing was actually weak for the iPhone as a whole, which implies a poor mix of phone sales in China towards the lower-priced models. U.S. and Europe were also down for Apple as a whole, which implies that there weren't great sales in developed markets either. The only real bright spot in terms of regions was India that Apple touted up 56% year-over-year. It's very possible that India becomes an above-average growth region for Apple over the next few years.

Mac sales were also disappointing in the second quarter. Usually Apple does a little bit better than the PC market. The PC market has been clearly struggling lately. Apple only barely did better than the market, it looks like, so that was another area of weakness. And also Apple Watch, the other product category, was about 2.2 billion in revenue. We think that implies that Apple sold about 2.5 million watches in the quarter. Again, far less than what maybe we would've expected a year ago. We're still not calling this product category a flop. Apple is still supporting it, the apps community is still supporting it. It sounds like the next version might have cellular connectivity. So there's still potential for this to be a mainstream hit and a growing category for Apple, so we wouldn't rule it out just yet. Certainly disappointing in the near term, but we wouldn't rule it out.

Apple services business was the bright spot, it grew 20% year over year, 27% when you look at the gross billings that customers pay for apps, and content, and things of that nature. They continue to tout services. We're still a little bit skeptical. The services, in our view, are a bit of a lagging indicator because so many people bought iPhones 12 and 18 months ago, they're now buying the services and the apps to go with it. So we don't think services is going to save the company if iPhone hardware sales continue to decline, but certainly it's nice to see that the customers using Apple and buying iPhones last year are continuing to use apps this year; that strengthens the ecosystem. We think it increases customer switching costs. We think those customers will continue to buy more iPhones.

Finally, the last big announcement from Apple was they raised the dividend by 10%. They raised their buyback by 35 billion to 175 billion in total, just massive numbers. There’s about 58 billion of the stock buyback authorization remaining. Again, with the stock trading a little bit below $100 today, we think Apple will be aggressive to buy back stock, and we like Apple's capital allocation moves.

Long story short, we think the company is still in a good long-term competitive position. It might take a few more months for this story to play out, and once the iPhone 7 and other new products are introduced before the holiday season. So, I wouldn't be betting on a great quarter in the summer months coming up, but still, we think the long-term picture is very bright.