Summary

  • Companies that are supported by secular growth tailwinds and pristine balance sheets, such as Apple Inc., are well-positioned to deal with the ongoing coronavirus (‘COVID-19’) pandemic.
  • We cover Apple’s latest earnings report and what to expect going forward in this article.
  • Apple offers investors a combination of dividend growth and capital appreciation upside.

Image Shown: Shares of Apple Inc. (NASDAQ:AAPL) have staged an impressive rally since bouncing off their March 2020 lows, with AAPL up over 50% year-to-date as of this writing on August 10 and that does not take dividend considerations into account. Later this August, Apple intends on completing a four-for-one stock split.

Companies that are supported by secular growth tailwinds and pristine balance sheets, such as Apple Inc., are well-positioned to deal with the ongoing coronavirus (‘COVID-19’) pandemic. Apple carries a stellar cash flow profile as the firm needs to make relatively modest investments in capital expenditures to generate enormous revenues. This makes generating free cash flows, defined as net operating cash flows less capital expenditures, a much easier task. Those free cash flows can be used to reward investors in various ways, such as making meaningful dividend increases and share repurchases possible (which we will cover in this article).

We have published several notes on Seeking Alpha this year highlighting why we like Apple (here and here), and are following up on thoughts in this piece. Shares of AAPL have surged higher this year, and given its stellar third quarter fiscal 2020 earnings report (period ended June 27, 2020) published on July 27, shares of Apple may have room to run further still.

In the upcoming graphic down below, we highlight Apple’s projected revenue growth over the coming fiscal years, derived through our enterprise cash flow models. The grey line represents our base case scenario, while the green dots represent our bear case scenario and the blue dots represents our bull case scenario.

Image Shown: Apple’s revenue growth trajectory is rock-solid, in our view. Image Source: Valuentum

Quarterly Overview

In the fiscal third quarter, Apple reported $59.7 billion in GAAP net sales, which was up 11% year-over-year. Strength at both its ‘Products’ and ‘Services’ divisions propelled Apple higher. As we have noted often in the past, we continue to be intrigued with the long-term trajectory of Apple’s Services division sales given the high margin nature of those revenue streams. Here is what management had to say on that issue during the firm’s latest earnings call (lightly edited):

“…We had strong performance in our digital services with all-time revenue records in the App Store, Apple Music, video and cloud services as well as elevated engagement on iMessage, Siri and FaceTime. Customers are loving new offerings across Apple services like Apple News today, our new daily audio briefing and Greyhound, our new summer blockbuster starring Tom Hanks.

In fact, Apple TV+ just hit a history making 95 awards nominations and 25 wins and accolades. Based on these results and our performance over the last four quarters, we are proud to announce that we have achieved our goal of doubling our fiscal 2016 services revenue six months ahead of schedule.”

Management noted that sales growth at Apple’s well-established “App Store, Apple Music, video and cloud services” led the charge at its Services division last fiscal quarter, supported by the company’s newer “Apple TV+, Apple Arcade, Apple News+ and Apple Card” services. Paid subscriptions rose by 35 million last fiscal quarter and now stand at approximately 550 million. Apple mentioned that the firm remains on-track to reach 600 million paid subscribers by the end of calendar year 2020, indicating its near-term growth outlook on this front remains quite promising. On the downside, Apple noted that advertising and AppleCare sales were negatively impacted by the pandemic last fiscal quarter, which appears to have been completely offset by strength elsewhere.

Pivoting to Apple’s Products division, net sales of iPhones, Macs, iPads, and ‘Wearables, Home and Accessories’ were all up year-over-year last fiscal quarter. The work-from-home trend encouraged the purchase of laptops, desktops, and tablets. Going forward, management is optimistic that the back-to-school shopping season will support Apple’s non-iPhone Products revenues this fiscal quarter given the potential for many students to continue to get schooled at home (which in particular is expected to support Mac and iPad sales). Apple’s Products division sales were further supported last fiscal quarter by the launch of the second-generation iPhone SE in April 2020, a more affordable iPhone offering.

For reference, Apple generated over $8.8 billion in gross profit (up 20% year-over-year) at its Services division on $13.2 billion in net sales (up 15% year-over-year) last fiscal quarter, good for a division-level gross margin of 67.2% (up ~310 basis points year-over-year). We strongly appreciate Apple’s ability to grow its division-level Services margin as that highlights the scalability of this business. Apple’s Products division generated $13.8 billion in gross profit (up 7% year-over-year) on $46.5 billion in net sales (up 10% year-over-year) last fiscal quarter, good for a division-level gross margin of 29.7% (down marginally year-over-year). We appreciate the resilience of Apple’s supply chain as that enabled the firm to meet brisk demand for its various products last fiscal quarter.

Please note that pent up demand, due to the negative impact COVID-19 had on key markets during Apple’s second quarter of fiscal 2020 (period ended March 28, 2020), is not primarily responsible for Apple’s strong performance in the fiscal third quarter. Apple posted modest year-over-year GAAP net sales growth in the fiscal second quarter, and that momentum continued into the fiscal third quarter.

In the upcoming graphic down below, we highlight our forecasts for Apple’s EBITDA generation over the coming fiscal years. The grey line represents our base case scenario, while the green dots represent our bear case scenario and the blue dots represent our bull case scenario.

Image Shown: We forecast that Apple’s EBITDA will continue climbing higher over the coming fiscal years. Image Source: Valuentum

Financial Strength Retained

Apple exited June 27 with $193.6 billion in cash, cash equivalents, short-term marketable securities, and long-term marketable securities on hand combined. Stacked up against $112.7 billion in commercial paper and repurchase agreements, short-term term debt, and long-term term debt combined, Apple continued to carry a massive net cash position of $80.9 billion at the end of its fiscal third quarter. That net cash position provides the firm with ample financial firepower to ride out the storm.

During the first three quarters of fiscal 2020, Apple generated $54.6 billion in free cash flow ($60.1 billion in net operating cash flow less $5.5 billion in capital expenditures). The firm spent $10.6 billion covering its dividend obligations and $55.2 billion repurchasing its common stock during this period. Some of its share repurchases were funded by the balance sheet. Apple reduced its outstanding diluted share count by over 5% year-over-year in the fiscal third quarter.

Promising Dividend Growth Trajectory and an Upcoming Stock Split

Shares of AAPL yield ~0.7% as of this writing. We see room for Apple to continue pushing through meaningful dividend increases, even during harrowing times such as these, given its high quality cash flow profile and pristine balance sheet. From August 2014 to August 2020, Apple grew its quarterly per share payout by over 74%. Going forward, we expect Apple will push through double-digit annual per share dividend growth over the coming fiscal years, and we strongly appreciate management’s commitment to rewarding shareholders through both capital appreciation and income generation-related upside.

Apple intends on pursuing a four-for-one stock split that is expected to be completed later this month. The goal of this maneuver is “to make our stock more accessible to a broader base of investors” according to management. While this will have no fundamental impact on Apple’s operations or financials on a company-wide basis, given the rise of day trading (otherwise known as gambling) during the pandemic from investors new to equity markets, it is possible shares of AAPL will become more appealing to certain types of investors at a lower per share price point.

Key Events

Reportedly, Apple intends to improve its mobile payment capabilities (likely for its iPhone) by acquiring Montreal-based Mobeewave for ~$0.1 billion. Mobeewave offers technology that allows users to tap their credit card or smartphone on another smartphone using Near Field Communications (‘NFC’) technology to process a payment. In an increasingly “cashless” world, the payment processing and payment solutions industry is supported by very powerful secular growth tailwinds and there is plenty of room for multiple winners in this space.

Probably the biggest near-term catalyst investors tend to pay close attention to is Apple’s iPhone launch cycle. Apple mentioned that the launch of its next-generation iPhone, which could be 5G-capable, is getting delayed by a few weeks due to the pandemic. Here is what management had to say during Apple’s latest earnings call (emphasis added):

“Similar to last quarter, given the uncertainty around the world in the near-term, we will not be issuing revenue and margin guidance for the coming quarter. However, we will provide some additional insight on our expectations for the September quarter for our product categories.

On iPhone, we expect to see recent performance continue for our current product lineup, including the strong customer response for iPhone SE. In addition, as you know, last year we started selling new iPhones in late September. This year we project supply to be available a few weeks later. We expect the rest of our product categories to have strong year-over-year performance.

For services, we expect the September quarter to have the same trends that we have observed during the June quarter except for AppleCare where during the September quarter a year ago we expanded our distribution significantly. As a consequence, we expect a difficult comp for AppleCare also considering the COVID related point of sale closures this year.”

The announcement of a modest delay in the next iteration of the iPhone did not seem to worry investors as shares of Apple soared after its latest earnings were published. Additionally, we appreciate that management expects Apple’s momentum at its Services division will continue going forward, keeping the headwinds facing AppleCare and the firm’s advertising segment in mind. We remain optimistic on Apple’s growth trajectory, though please keep unforeseen pandemic-related headwinds in mind.

Concluding Thoughts

Apple is one of the best-positioned firms to ride out the storm created by the ongoing COVID-19 pandemic. The tech giant offers investors a combination of income growth and capital appreciation upside, and should new growth opportunities arise, Apple can leverage its financial largess to its advantage. Apple is one of our favorite companies to ride out the pandemic.

Author: Callum Turcan

Source: Seeking Alpha: Apple Surges Higher Ahead Of Stock Split

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