Apple FQ2 2020 – The olive branch

Withdrawal of guidance unsettles the market.  

• Apple reported good results but withdrew its guidance offering instead an olive branch comprised of a dividend increase and share buyback.
• FQ2 2020 revenues / EPS were $58.3bn / $2.56 ahead of consensus of $54.25bn / $2.26.
• Apple has real exposure to China and saw a lot of fluctuation in its business during the quarter with first China closing down then re-opening followed by the rest of the world.
• Furthermore, the overall results were meaningfully boosted by the services business which saw a 17% YoY increase in revenues.
• This comes as no surprise as with everyone stuck at home with nothing to do, engagement with digital services has increased by 32% QoQ.
• Hence, more people will be buying content from Apple and signing up for its services producing the growth observed.
• The impact of this pandemic is likely to keep this growth elevated for a while as the trend towards streaming has been greatly accelerated by the lockdown.
• However, the hardware business looks to me like it is going to have a difficult year.
• Some of the first estimates for the smartphone market in Q1 2020 are coming in with Counterpoint research estimating a YoY decline of 13%.
• Q2 2020 is likely to be worse meaning that even with a strong bounce back in H2 2020, the figures for the year overall are likely to be pretty weak.
• Hence, I continue to think that the smartphone market will decline somewhere between 10% and 20% this year as users push out replacement purchases.
• This should come back with a wave of catch up replacement sales when the economy comes out of recession, but this could be a couple of years away.
• Apple already has a dominant position in the segment of the market that it occupies and so the scope to grow market share to offset the impact is quite limited.
• Apple will get some cushioning from services as well as Macs and iPads as these have a strong use case from the home working and homeschooling trends but they are not big enough to fully offset the iPhone juggernaut.
• The real problem is the uncertainty where Apple, just like pretty much everyone else, has no real idea how the next few months and quarters are going to play out.
• This is why it has withdrawn its guidance and it is this uncertainty that caused the shares to slip in after-hours trading.
• Not even the olive branch of a 6% dividend increase and more share buybacks could soothe the frayed nerves as it is uncertainty that the market hates the most.
• The figures from Counterpoint will also not help as they are pointing to FQ3 2020 being much more difficult than FQ2 2020.
• Hence, I continue to think that the outlook for Apple is not that great for 2020, putting it in a more difficult position than most of its ecosystem peers (Google, Facebook, Amazon, Microsoft etc).
• This puts its relative valuation at risk where it is trading broadly in line with Google and Facebook who arguably should now be at a premium.
• Apple has been at a low valuation before, there is no reason why it cannot go there again.
• The hardware monetisation mechanism remains my least favourite during the pandemic and the economic chaos it has caused, followed by advertising and then subscription.
• The cloud remains at the top of the pile and there I think it will remain for a while.
• Apple has rallied strongly of its lows, creating an opportunity to switch into something else.