Apple Q2 Earnings – Crestwood Advisors

Current Price: $159 Price Target: $185

Position Size: 7.9% TTM Performance: +23%

Key Takeaways:

Hitting record sales across categories despite supply chain constraints. The exception is iPad which is experiencing the most severe shortages.
A few headwinds…$4B to $8B impact to next Q revenue due to supply chain constraints. Next Q should be ~$85B in rev for perspective, so a mid to high single digit impact in the Q. Also, Covid restrictions having an impact to demand in China. And finally, seeing a 150bps headwind from Russia.

Getting better? “On a positive front, almost all of the affected final-assembly factories have now restarted,” said, Tim Cook. “We’re also encouraged that the Covid case-count that’s been reported in Shanghai has decreased over the last few days.”
Better positioned…an article from WSJ underscores the advantage of owning market leaders like Apple that have big buyer power w/ their suppliers…while not immune to supply chain issues, they have an advantage in navigating them. https://www.wsj.com/articles/apple-suppliers-given-priority-for-factory-restarts-in-shanghai-region-11651250518?mod=Searchresults_pos3&page=1

M1 success underscores their silicon and software advantage – they design their own chips for iPhone, iPad and Mac…making them one of the largest semiconductor companies in the world and giving their products an advantage b/c, not only are they some of the most advanced chips, they can tightly customize how their software and hardware work together. Apple points to success w/ Mac as evidence…which has strung together its best 7 quarters in history
Asked on the call about M&A intentions…NFLX was specifically mentioned in the question. Mgmt. said they are always looking for opportunities, they usually do smaller acquisitions, but wouldn’t rule out a larger one. NFLX market cap is now $87B…AAPL has $193B in cash on their balance sheet and produces over $100B in FCF annually.
Increased buyback authorization by $90B.
Reasonable valuation…

Trading at ~4.5% FCF yield, in line w/ the S&P, w/ another almost 3% of their market cap ($73B) in net cash on their balance sheet.
For reference, pre-pandemic in Jan 2020, Apple was trading at ~4.7% FCF yield and 1% dividend yield with ~7% of their market cap in net cash.
AAPL is down about 10% YTD (less than the tech sector) while forward FCF estimates have continued to go up.
Their market cap has been tracking their massive increase in FCF estimates. FCF this year should be ~85% higher than pre-pandemic fiscal 2019
They have a huge amount of cash on their balance sheet w/ years of buybacks to support valuation

Capital returns may need to expand further to hit their net-cash-neutral target in a few years.
With current net cash of ~$73B and expectations of over $470B of FCF over the next 4 years, shareholder returns could be well over $500B or >20% of their current market cap.
They’ve returned >$550B since 2012. So, from 2012 to 2026, they may return well >$1T.

Quotes from the quarter & WSJ article on their Silicon Advantage…

“With Apple silicon, our teams are pushing the limits of what we once thought possible, and we are seeing leaps and bounds in performance and efficiency. Last month, we announced another breakthrough with M1 Ultra, the world’s most powerful chip for a personal computer. The incredible customer response to our M1-powered Macs, helped propel a 15% year-over-year increase in revenue despite supply constraints.”
“And with the all new iPad Air supercharged by M1, iPad brings more power and more versatility across the entire iPad lineup. For customers around the world, iPad continues to be essential for education, creativity, and entertainment. That’s why we’re continuing to see such a strong demand for iPad, even while navigating the significant supply constraint we predicted at the start of the quarter.”
From WSJ: “Mr. Srouji’s (head of Apple’s chip design) chip operation, which already designed chips that power iPhones, has helped Apple improve the profitability of its smartphones and computers. It also has positioned Apple to move into potential future products such as a car or extended-reality headsets.”
https://www.wsj.com/articles/the-chips-that-rebooted-the-mac-11650081649

Additional highlights:

5G upgrade cycle – only in the early innings of 5G. If you look at their 5G penetration around the world, there is only a couple of countries that are in the double digits yet.
Why we still like…

Big moat underpinned by growing installed base which drives their virtuous cycle.. More users of their devices lures developers to create better apps which lures more users. This is key to their LT growth. Apple continues to significantly expand their installed base. And they have multiple new products being launched and more in the pipeline (e.g. AR glasses, Apple car) that could be key drivers of LT growth….and, importantly, a growing services business tied to all these products. Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads and now their Macs, which gives them better control over performance and feature integration in their devices. This has proven to give them an advantage with the way they design their products and an advantage with developers. So, now they have Macs, iPhones and iPads running the same underlying technology which should make it easier for Apple to unify its apps ecosystem, including allowing iPhone and iPad apps to run on Macs. This advantage and the relevance of their ecosystem gets more and more important as computing power in phones increases, 5G delivers better connectivity and, as a result, we have the ability to use their devices in enhanced ways (w/ increased revenue opportunities) ….like apps that take advantage of augmented reality and IoT related technologies.

$AAPL.US

[category earnings]

[tag AAPL]

Sarah Kanwal

Equity Analyst, Director

Direct: 617.226.0022

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109