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Apple Roundup: Negative Preannouncement, Samsung Deal

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Apple (AAPL - Free Report) usually trades at a premium to the S&P 500 and it has lived up to that standard all through the past year. And that’s despite its decision to no longer provide hardware unit sales numbers to turn focus to its emerging services business. The shares took a beating then, as well as after its negative preannouncement, while continuing to lead the S&P 500 by a mile-

 

 

But estimates have come tumbling down as analysts began to get a sense of just how much of a decline the hardware business was in for: by 22.6% for the December quarter, 11.9% for the March quarter, 9.7% for fiscal 2019 and 8.4% for fiscal 2020.

The chart below shows that even after the correction, both 2019 (light blue line) and 2020 (red line) estimates continue to represent significant growth from comparable prior year periods.

 

At 12.20X forward 12 months P/E, the shares are trading below their 5-year median, which is probably fair because of the uncertainty surrounding the core business-

Here are the top stories for last week-

Sales Warning

On Jan 2, Apple lowered its revenue guidance for the holiday quarter from $91 billion (at the mid-point) to $84 billion, its gross profit from $34.8 billion at the mid-point to $31.92 billion, its operating expense from $8.75 billion to $8.7 billion (effectively lowering operating income from $26.05 billion at the mid-point to $23.22 billion) and its other income from $300 million to $550 million. Applying the tax rate of 16.5% (unchanged) to the after-tax income, guided net income reduced from $22.00 billion to $19.85 billion.

Apple’s Tim Cook blamed the economic slowdown in China to the sales weakness. In a note to investors he said, “Most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad”. He also said that the slowdown in economic activity as a result of the government’s credit tightening policies added to the continuing tensions from the trade conflict with the U.S., ultimately leading to lower footfall at its retail outlets. He also mentioned that “market data has shown that the contraction in Greater China’s smartphone market has been particularly sharp”.  

In a subsequent interview, he said that there was limited if any anti-America sentiment as an offshoot to the trade war although independent media continues to point at growing Chinese patriotism and the availability of quality smartphones of Chinese make.

Slower iPhone sales in China (one of its largest markets) aren’t a particularly encouraging signal given strained sino-U.S. relations and recent market gyrations. If negotiations fall through, iPhone parts will come in for some rather heavy tariffs and Apple maintains that there isn’t adequate expertise in the country to allow a production shift back to the U.S. So prices of iPhones (a high end consumer good) will rise and a corresponding impact on sales will follow. Investors could see this as another sign of general economic weakness.

Samsung Deal

Apple has a new deal with long time frenemy Samsung that will see Samsung add an app on its TVs that will let users browse and play their existing iTunes movies and TV shows or buy/rent new ones.

The financial terms aren’t public, so we don’t know what Apple is paying. But Apple wants to get in deep on the very popular TV maker’s devices, so the agreement also covers its AirPlay 2 software so iPhone owners can stream content from their phones to their Samsung TVs.

Apple’s intentions are obvious: first, to grow its services revenue as fast as possible to offset the increasing pressure on device sales; second, to woo Android device owners into its ecosystem and failing that, to profit from them where possible; and three, to increase options for Apple device owners by letting them stream phone content onto their Samsung TVs. Since Apple TV hasn’t been wildly popular, the need to combine with leading TV makers is all the more important, especially as it gets ready to launch its video streaming service in the second half of the year.  

Recommendations

Apple shares carry a Zacks Rank #3 (Hold). Technology companies worth buying instead are #1 (strong buy) ranked STMiroelectroncs (STM - Free Report) , SS&C Technologies , Cogent Communications (CCOI - Free Report) and Identive (INVE - Free Report) .

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