Apple Surges After Strong Earnings, Stellar Guidance Offset Disappointing iPhone Sales, Service Revenues

First, three quarters ago, Apple shocked investors when it said it would no longer disclose the number of iPhones it was selling - a clear signal that selling had slowed dramatically. Shocked investors sold off the stocks... then BTFD with gusto sending AAPL sharply higher. A few months later, on January 3 2019, Apple once again shocked the market when it slashed its revenue guidance by 8% for only the first time since this century (naturally, it blamed China). As AAPL stock tumbled, it reveberated across all capital markets, and even prompted a flash crash cascade in most yen and pound pairs. However, just like a quarter earlier, Apple's "shock" was quickly overcome, and the after hours plunge actually marked the max pain for longs, and as the chart below shows, AAPL has soared 46%. And to think all it had to do was slash revenue guidance..

Then, last quarter, as largely expected, Apple reported that iPhone sales had indeed slumped, but the reason why the market kept bidding up the stocks, was the company's effervescent outlook, which while declining on a year over year basis, was well above sellside consensus, dispelling fears of a growth slump and boosting hopes that Apple is successfully transitioning to a services company (the new $75 billion stock buyback repurchase authorization did not hurt). As a result, heading into its third quarter, AAPL stocks was trading near the highest levels of the year, and not too far from its all time highs.

So with US-China trade talks resuming today, Trump's twitter rant notwithstanding, everyone's attention was glued to the Apple earnings report at 430pm ET to see if all the optimism over the past 3 quarters would be justified.  The answer appears to be yes, because moments ago, Apple reported that in fiscal Q3, it beat both revenue and EPS earnings:

  • Q3 EPS: $2.18, Exp. $2.10
  • Q3 Revenue: $53.8BN, Exp. $53.35BN
  • Q3 Gross Margin $20.23BN
  • Q3 Product revenue: $42.35 billion

Apple also announced that it had repurchased a whopping $17BN in stock in the quarter, and spent $3.6BN on dividends. After the buybacks, AAPL's diluted shares declined by 1 million, from 4.7BN in Q2 to 4.6BN in Q3.

While Apple beating on earnings was great news (and the extravagant buyback certainly did not hurt), less impressive was Apple's iPhone revenue, which came in at $25.986BN, below the $26.45BN expected, and well below the $29.5 billion from a year ago, as well as the slight miss in services revenue which came in at $11.46BN, below the $11.88BN consensus.

Another disappointing data point: China revenue came in at $9.16BN, down 4.1% Y/Y; China was one of the two geographic regions that posted a Y/Y revenue decline in the quarter (Europe was the other).

The full breakdown by geography is as follows:

CEO Tim Cook said “the results are promising across all our geographic segments, and we’re confident about what’s ahead.” He also noted that in constant currency, revenue in all areas grew so Apple joins the parade blaming slowing sales on a strong dollar.

Looking at the product breakdown, Apple confirmed that the iPhone craze has long since peaked, when it announced that it sold:

  • iPhones: $25.99BN, below the $26.54BN expected
  • iPads: $5.02BN
  • Macs: $5.82BN

Something worth pointing out: iPhone sales Q3 represented about 48% of revenues, the first time that the product has made up less than half of sales in several years.

As Bloomberg further notes, Apple has pointed out that iPhone sales are flat/slowing in part because people hold on to their iPhones longer and other market conditions. But this trend actually coincided with prices topping $1,000 and the redesign cycle switching from every 2 years to 3 years.

What is perhaps more remarkable, is that in Q3, the Apple Watch/Wearables category generated $5.53 billion in sales, and topped the iPad in total revenue. Once Apple's next big hit under Steve Jobs, the iPad has now become a small revenue driver for Apple.

Yet despite the disappointing iPhone sales, the reason why the stock is some 3% higher after hours was largely due to the company's revenue and gross margin outlook, which came in well above the Sellside estimate:

  • Q4 revenue between $61 and $64 billion, exp. $61.04BN
  • Q4 gross margin between 37.5% and 38.5%, exp. 37.5%

Commenting on the earnings, Apple CFO Luca Maestri said that "Our year-over-year business performance improved compared to the March quarter and drove strong operating cash flow of $11.6 billion. We returned over $21 billion to shareholders during the quarter, including $17 billion through open market repurchases of almost 88 million Apple shares, and $3.6 billion in dividends and equivalents.

Looking at the company's increasingly important service revenue number, Apple reported $11.46BN in service revenue, up from $10.2BN a year ago, but below the $11.88BN expected by analysts, and virtually unchanged from the prior quarter.

Putting this in context, services have now jumped to contributing a fifth of total sales for Apple, or 21% in Q2 to be precise. That said, for this services story to keep growing (and not disappoint analysts in the future), and playing out, the TV portion will have to become more important.

And an interesting observation: while AAPL's gross cash (not net of debt) was $15BN lower sequentially to $210.6BN, net cash dropped again, and is now down to just $102BN, the lowest since the end of 2011.

And for all those waiting for their shiny, new Apple/Goldman credit card, on the call Tim Cook confirmed on Apple's earnings call that the upcoming Apple Card is launching in August. Bloomberg News reported earlier this month the card would launch in the first half of the month. Cook also confirmed that thousands of Apple employees have been testing the upcoming card, which is launching in partnership with Goldman Sachs.

So the bottom line: a modest profit beat, coupled with weaker than expected iPhone and Services revenue, offset by very strong guidance, which is enough to push AAPL stock 4.3% higher to $218, just above the price shares peaked at ($215.31) the day after Apple's last quarterly report.