We were expecting the Apple’s June quarter numbers to be noisy, magnified by the pandemic. We were wrong.
Apple’s June quarter results clearly outpaced expectations on iPhone, Mac, and iPad (67% of revenue). The numbers reveal a company that is best positioned among big tech to reaccelerate revenue growth over the next year and sustain that high growth for the following two years. Beyond the multi-year 5G cycle, Apple has dependable revenue tailwinds from products that tap into long-term undeniable growth movements including digital health, working and learning from home, services, and autonomy.
While we caution that 2020 will remain unpredictable for all companies, we believe Apple’s cash position and product roadmap put shares of AAPL on a path to reach $500 and well beyond in the years ahead. (Note that all references to stock prices in this note reflect pricing before the 4 for 1 stock split scheduled to take place in the last week of August.)
Key June quarter metrics:
- Revenue and Earnings growth jump higher. Revenue was up 11% y/y in the June quarter compared to an average of 0.4% y/y revenue growth over the previous six quarters. GAAP EPS was up 18% y/y compared to an average of 3% y/y earnings growth over the previous six quarters. Revenue and earnings growth in the June quarter reflect incredible resilience in Apple’s business in the face of a global health crisis.
- iPhone (44% of sales) base has stabilized. Apple’s biggest surprise of the quarter was 2% y/y growth in iPhone revenue. Wall Street expected iPhone revenue to be down 15% y/y in the quarter. iPhone sales grew despite production headwinds, retail closings, and general economic uncertainty. The growth is a testimony to the loyal active iPhone base that is now at an all-time high. It also appears the iPhone replacement cycles are beginning to stabilize after five years of elongation. That sets up favorable iPhone growth for the next two-plus years.
- iPhone 5G. Luca Maestri’s comments on the call suggested that the new iPhone lineup will be available sometime in October. Given the lack of 5G coverage in 2021, we do not expect iPhone 5G demand to ramp until 2022. In the meantime, the balance of the iPhone lineup should drive growth in the high single-digit for the next year, up from 2% in the June quarter.
- Mac (12% of sales) and iPad (11% of sales) enjoy stay at home boost. The magnitude of the Mac and iPad outperformance was also a surprise. Mac revenue (12% of sales) was up 22% y/y and iPad revenue (11% of sales) was up 31% y/y. We expect the strength in this segment to continue through the end of the year, drifting back to mid-single-digit growth in 2021. The pandemic appears to be expanding Mac and iPad market share with Luca Maestri commenting, “Around half of the customers purchasing Mac and iPad during the quarter were new to that product and, as a result, the active installed base for both products reached a new all-time high.”
- Services (22% of sales). Services were up 15% y/y compared to 17% y/y growth in the March quarter. The slower growth was due to a decline in Apple Care revenue from Apple retail store closings. The balance of the Services segment performed in-line or ahead of our expectations. One future wild card on Services remains the low likelihood for new industry-wide app store regulation, which would be a near-term headwind to App Store revenue. We estimate App Store revenue to represent about 5% of Apple’s overall revenue.
- Wearables (9% of sales). Apple does not report an official wearables metric but frequently comments on the segment’s sales trajectory. We estimate wearables were up about 20% y/y in the June quarter compared to up 44% y/y last quarter. The deceleration was expected, given last quarter the company guided for a slowdown in the segment. While it was a deceleration in growth, we expect growth in the segment to reaccelerate following the iPhone’s return to growth in the quarters ahead. Apple Watch, which launched five years ago, is still in front of a large, untapped market. As evidence, the company reported 75% of Apple Watch buyers in the June quarter were new to the product. We estimate that less than 10% of iPhone owners have an Apple Watch and believe that metric could exceed 35% over the next five years.
- Cash: Apple ended the June quarter with $194B in total cash including $113B in debt, or $81B in net cash. We had expected total cash at the end of June to be $185B including $110B in debt, or $75B in net cash. The topic of Apple’s cash position is more complex than its cash balance. Apple has outlined a goal to be net cash neutral over time, suggesting that total cash will eventually equal debt. This is good news for investors—in the years ahead, they can expect an additional $81B in cash to be returned through buybacks and dividends or otherwise strategically deployed. Some of that cash has already been committed to investors through the company’s capital return program. The challenge is that the company is generating so much net income that the road to net cash neutral is long and slow. Apple has generated $58.4B in net income over the past four quarters and returned $89.9B in capital, or net $31.5B returned to shareholders over the year. At this pace, it will take the company two to three years to be net cash neutral. In the end, Apple has a good problem when it comes to cash—a gravy train of cash returning to investors, which is not fully appreciated.
The months ahead should favor Apple
The months ahead have many unknows. What we do know is that Apple entered the pandemic strong and the company’s products are an even more foundational part our lives today as we work, live, and play from home.
The long-term path to AAPL at $500 and beyond
Despite the favorable June results, 2020 is full of economic and market uncertainties. However, the powerful trends that were in place within technology, media, and health will still be in place when this period ends. The trends that Apple will ride over the next decade include:
- 5G driving both a device upgrade cycle and trailing benefits from what the technology enables.
- Original content and streaming entertainment garnering a larger share of media consumption.
- Software services continuing to penetrate more industries.
- The growing use of Apple Pay.
- Health becoming personal and preventative—wearables for data collection, AI for analysis, and consumer software as the interface.
- Augmented Reality emerging as the next major computing platform with Apple Glasses available sometime around 2022.
- Autonomous systems—while it’s unclear what form it will take, we expect Apple to make an entrance into autonomy.
In other words, Apple has positioned itself such that many of the prevailing winds over the next decade are at the company’s back. Additionally, the 2020 downturn may prove to be a positive for the company. Apple will leverage its financial strength, anchored by $194B in cash, to retain and acquire talent and technologies that will advance the company’s agenda.
Putting it all together, we’re optimistic regarding Apple’s prospects over the next five years. We believe the company can generate $22.00 in GAAP earnings in 2023. As a point of reference, the handful of analysts modeling out to 2023 are currently expecting GAAP EPS of $17.40. Applying a 23x multiple to our $22.00 2023 earnings estimate yields a $506 share price. Multiple expansion provides an additional avenue for upside well beyond $500. Shares of AAPL currently trade at a multiple below that of the other FAANG companies.
The indirect effects of COVID-19 are accelerating growth for Amazon. The company reported Q2 results well ahead of Wall Street expectations driven by two key drivers:
- Consumers are shopping online more. North America retail revenue grew 44% y/y in Q2, an acceleration from 29% y/y growth in Q1. Our changing shopping habits drove impressive volume for Amazon’s retail business. New and existing customers used Amazon as a critical resource in Q2.
- Demand for cloud services is up. The shift to distance learning, an increase in gaming, and more video-based communication all contributed to more demand for AWS. As a result, segment revenue was $10.8B in Q2, up 29% y/y, driving record profitability for the company. Note that Amazon’s AWS segment contributes more operating income ($3.36B in Q2) than the NA Retail segment ($2.14B in Q2). Growth in AWS generally accelerates growth in profitability.
Ecommerce just saw a two-year time warp
US ecommerce penetration went from 16% of retail spending in the first quarter of 2020 to 40% in the month of May. Yes, ecommerce growth accelerated, but note that physical retail was also shut down in May, so both sides of that ratio moved in favor of ecommerce. We expect US ecommerce to grow ~30% in 2020 and, based on eMarketer data, we expect physical retail to shrink by 14% in 2020. We expect ecommerce to settle well ahead of where it was, 20% to 25% of all retail, as car dealerships, gas stations, etc. come back. That represents a two-year time warp for ecommerce, pulling forward what had previously been a slow and steady, undeniable trend.
Amazon’s guidance suggests COVID-related trends will continue
Amazon’s bullish Q3 revenue guidance of $83B to $97B was above consensus of $86.1B at the midpoint. Guidance suggests that the company expects recent tailwinds will persist. Guidance for Q3 operating income of $2B to $5B was ahead of consensus ($3.1B), despite the company’s reluctance to show profitability.
The way that we shop, work, and play is changing quickly. Amazon is a clear beneficiary of many of the changes brought on by COVID-19.
Today, CEOs from Amazon, Apple, Facebook, and Google spent five hours testifying virtually before the House Judiciary Antitrust Subcommittee. Executives faced questions related to the power their companies have over a wide array of issues including fair competition, the digital marketplace, influence on public opinion, political agendas, and privacy. Overall, Apple fared well, Amazon was more neutral, while Google and Facebook had a longer day.
Regulating big tech appears to have bipartisan support
From a high level, the hearing was more about subcommittee members framing their views of why big tech should be regulated and advancing their own political agendas. The hearing did not appear to be a fact-finding mission with the leaders of the most influential tech companies.
A century of antitrust framework is already in place
The purpose of the subcommittee is to explore new anti-trust laws to regulate big tech. It’s too early to determine if new legislation will emerge from the committee’s work, and it’s important to note that there is already an anti-trust framework in place. In other words, the subcommittee may yield no new legislation, only a recommendation to enforce existing policy. That enforcing of existing laws may embrace the status quo or be problematic for some of the companies attending today.
This topic will linger for years
While today was a historic gathering of tech leadership, the antitrust conversation began to build momentum a year ago and will likely take multiple years to resolve. The greatest risk related to the topic of regulation for each of these companies is a prolonged distraction, diluting the focus on innovation. Microsoft experienced this very same distraction starting in 1998 and ending in 2004, including appeals. That distraction was costly and arguably played a role in Microsoft missing the mobile opportunity.
Today’s winners and losers
Given the subject matter and confrontational nature of these hearings, we view today’s winners as the companies that received the fewest unique questions and the losers as the companies that fielded the most unique questions. These questions loosely reflect the subcommittee’s long-term regulatory focus. In total, we counted 76 unique questions asked.
- Winner, Apple: Apple received 15 questions, about 20% of all questions asked. Cook fielded questions related to the App Store take rate along with policies regulating app availability. Beyond the number of questions, the topics for Tim Cook largely orbited around the App Store, which we estimate accounts for about 5% of Apple revenue. By comparison, the other tech companies fielded questions that impacted the majority of their revenue.
- Neutral, Amazon: Amazon received 18 questions, about 24% of all questions asked. Bezos fielded questions regarding third-party data collection practices, preferential treatment for Amazon goods, and policing counterfeit goods.
- Loser, Facebook: Facebook received 21 questions, about 28% of all questions asked. Zuckerberg fielded questions regarding Facebook’s role in free speech, anti-competitive M&A philosophy, product innovation, and social justice.
- Loser, Google: Google received 22 questions, about 29% of all questions asked. Pichai fielded questions regarding search result rankings, suppression of conservative views, and Google’s corporate values, and Google’s ad network.