- Apple is likely to beat on earnings/revenue in the next two quarters.
- Fundamentals position investors favorably with iPhone revenue likely to grow in mid-teens.
- Investors should remain cognizant of volatility over the long run.
While the consensus view is fairly consistent and more narrow when it pertains to iPhone shipment estimates/forecasts there’s a heightened degree of variability when it comes to average unit pricing. This is due to recent trends in channel checks, Samsung Galaxy Note 7 (disaster), and survey responses indicating which iPhone model consumers are looking to buy.
Furthermore, we’re entering into Apple Inc.'s (NASDAQ:AAPL) most volatile season, which will force us to be conscious of timing entries and protect the downside.
Through conversations with investors, Simona Jankowski from Goldman Sachs mentioned that buy side managers are now shifting to a thesis of a two-phase megacycle, which also happens to be my thought process so far.
Rod Hall from J.P.Morgan mentions in his most recent report that mix-shift to the phablet version will have a limited financial impact, and promotional activity in China is mostly limited to China Unicom. That being the case, Rod Hall is on the more conservative end of the spectrum when compared to the rest of the analyst consensus.
Knowing the pricing events, patterns and timing
There’s uncertainty on unit revenue as the 32 GB model wasn’t available at launch. The lower-tier model is expected to launch in October. To further complicate things, the upgrade program for 6S/Plus to iPhone 7/Plus implies heightened demand from early adopters given the very generous $650 credit from all four U.S. telecoms. The promotional activity was less substantial in Asia, but with the Americas composing 42.4% of consolidated revenue, the impact will still be noticeable.
Luca Maestri (CFO) usually provides guidance based on 4-weeks of data. It’s estimated that Apple will report its earnings/revenue on Oct. 25th, whereas Apple’s fiscal year ends on Sept. 27th. In other words, whenever the CFO makes his projection, he’s making it based off of 4-weeks of historical data, plus his assumption on what the next 8-weeks will look like.
He’s got another month of actual data ahead of the consensus, which is why analysts often defer to CFO's outlook. In fact, the consensus range tends to hover near the outlook provided by CFO at most publicly traded companies, but it’s in my view that the predictive value of Apple’s outlook has become less meaningful.
According to UBS analyst Steven Milunovich:
The UBS Asia tech team's latest estimates show iPhone 7 procurement plans for F17 have increased from 80mn to 89mn, mainly due to 7 Plus needs. This figure is higher than the iPhone 6s procurement of 87mn but lower than the 93mn for the iPhone 6, which fits with our thesis.
Given the mid-quarter shift in iPhone builds, it’s likely that Maestri’s estimate won’t be as precise, as it’s difficult to predict production ramp ahead of better than anticipated demand. In other words, Apple’s CFO may be sitting on enough data to make an aggressive projection, but given their historical tendency of conservatism ahead of major quarters, it’s in my view that the outlook figure won’t provide as much predictive value.
The situation is a little too unique even for one of the world’s most intelligent CFOs.
Uncertainty in Q1’17 figures is embedded into a lot of buy-side models. The next two quarterly earnings calls have become much more actionable.
If I’m right, the outlook is conservative but above Q4’16 consensus which will drive the share price higher after the announcement.
But, when we roll around into January, the consensus will utilize channel checks to arrive at figures in-line with actual figures of appx. 4 to 6 weeks prior to the reported earnings date.
Therefore, buy-side managers (who have access to this data) will likely bid the stock after Q4’16 results are announced, and prior to the announcement of Q1’17. Therefore, the rally will likely sustain for a concentrated period of time before consolidating in mid-winter.
This implies that investors who are looking for the most optimal cost basis should be overweight (maintain higher portfolio weightings of Apple) in the months of September through December, and then shift allocations to a more normalized weighting (in-line with risk objectives of course) in the weeks leading up to the mid-point of January.
The stock will likely move in this directional pattern as information is priced into the stock at key points of the earnings cycle. Keep in mind that timing of new information has stayed fairly consistent, but outcomes tend to vary.
iPhone ASPs (average selling price) remain the biggest variable
As I have mentioned in the introductory paragraph, there are a lot of moving parts to iPhone ASPs. I have yet to put together a WARP (weighted average retail price) model, so this is more supplementary commentary.
Wamsi Mohan from Bank of America Merrill Lynch takes on the challenge of predicting pricing:
We consider various ASPs and Gross Margins for the iPhone 7/7 Plus. The mix of phones sold (screen size, capacity) will determine the exact ASP and gross margin. We assume an average ASP of $767, and Gross Margin of 43.8% based on the mix of iPhones shown in Figure 3. We then vary the ASP higher and lower, as well as the GM in order to determine impact to ASP.
Keep in mind that the ASP assumption is inclusive of only the 7/Plus in Mohan’s quote. His ASP including lower-end models is currently $640 for FY’17.
Apple has consistently revised orders higher, which goes back to the corollary of Apple’s CFO guiding conservatively. Apple burned a lot of inventory going into Q4’16, so Apple’s lack of production implies more upside to production. It’s worth noting that Apple’s supply chain isn’t as flexible due to the new waterproofing feature.
Survey data from PiperJaffray from their launch day survey implies 54%/46% are buying iPhone 7/7 Plus respectively. Keep in mind, Mohan from BofAML is anticipating 60%/40% for iPhone 7/7 Plus respectively, so Mohan’s ASP assumptions could prove conservative.
Kulbinder Garcha from Credit Suisse, on the other hand, is anticipating blended ASPs (including prior/current) at $661 (much higher than Mohan). Garcha is near in-line with the consensus view on his shipment/revenue estimate for FY’17, as he’s still anticipating 2018 (super-cycle), which is why he’s conservative on shipments.
I’m taking on the view that the super-refresh is already occurring and is spread between FY’17 and FY’18 with ASPs likely in the $650 to $660 range. As such, we’re walking into a blowout quarter, assuming shipments grow high-single digits, and ASPs increase mid-single digits. In that scenario, iPhone revenue grows 14.45% y/y. Investors are likely embedding 10%+ y/y revenue growth in the iPhone segment.
Why isn’t anyone else making extremely bullish calls?
Well, let’s rewind back to last year when analysts (including myself) got too excited and the actual reality proved to be much worse. Apple’s ship went diving… talk about some future tech. The passengers/investors on board plummeted far below the surface… before making it back up.
For now, it seems safe enough to buy a ticket aboard the Apple express, but keep in mind that investor risk appetite limits multiple expansion given historical volatility.
I continue to reiterate my high conviction buy recommendation for Apple stock.