Apple’s Quarter in 3 Words: Accelerating Digital Transformation

Apple’s Quarter in 3 Words: Accelerating Digital Transformation

Apple reported December quarter results above Street expectations, with overall revenue up 21% compared to Street expectations of 12%. There’s evidence of this accelerating digital transformation in the fact that the upside was driven by nearly every product category (Mac was in line but was also supply-constrained). Further evidence of this transformation is the company reporting historic revenue during a time of historic financial stresses for consumers.

At its core, our opinion that Apple’s best days are still ahead is based on a belief in a digital transformation that we cannot yet fully comprehend. Separately, the company grew its base of active devices by 10% over the past year, to a record 1.65B. This device growth includes first-time Apple buyers, that if history repeats itself, will become future recurring revenue.

What is driving Apple’s new growth curve?

Apple is advancing into its new growth curve. We continue to believe 2021 will be a year marked by four positive drivers:

    1. The accelerating digital transformation means more people are working, learning, and playing at home. This provides a continued tailwind for the iPad and Mac businesses (about 25% of total revenue). We believe these two segments can grow at 10% plus in 2021 and 2022, compared to flat growth over the last few years. Services revenue is also benefitting from pandemic-related consumer habits. We expect these tailwinds to persist for the better part of 2021.
    2. 5G enthusiasm will grow in the back half of the year, starting a two to three-year iPhone upgrade cycle.
    3. While Street FY21 revenue growth estimates of ~15% are in line with our 16% expectation, we believe consensus estimates for FY22 of 5% y/y revenue growth are too low. We expect those estimates to inch higher throughout FY21. Ultimately, we believe FY22 revenue growth will be closer to 10%.
    4. Growing anticipation of new business segments that likely won’t launch until 2022 at the earliest. We expect hardware subscription offerings that build toward a 360° bundle, along with growing optimism around a massive expansion in the company’s addressable market with Apple Car.

How to think about the stock: The case for $200

Our opinion for a base case $200 AAPL share price in two years remains unchanged. Given this view is based on a two-year outlook, we’re shifting our methodology to our FY23 earnings number, which we currently estimate to be $5.75. A year from now, investors will be factoring in 2023 expectations; therefore, we feel our valuation logic is appropriate.

Key December metrics:

  • Guidance: Apple doesn’t formally give guidance, rather, high-level direction on its earnings call. The company said it expects normal seasonality from the December to March quarter. Over the past three years, March quarter revenue has been down on average 33% from December. This average seasonal decline is already reflected in Street numbers. As an aside, shares traded down slightly following CFO Luca Maestri’s seasonality comment, suggesting some investors may have been hoping this March would have outpaced historical seasonality.
  • Cash: Apple ended the Dec. quarter with $196B in total cash and $112B in debt, or $84B in net cash. We expected total cash at the end of Dec. to be $185B, with $112B in debt, or $73B 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—they can expect in the years ahead an additional $84B in cash will 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, particularly in a holiday quarter, that the road to net cash neutral is long and slow. They can’t get rid of it fast enough. 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.
  • Revenue: Dec. quarter revenue was $111.4B (up 21% y/y) compared to the Street at $103.2B (up 12% y/y), driven by upside in nearly every product category (Mac was in-line but was also supply-constrained).
  • Earnings: EPS was $1.68 (up 35% y/y) compared to the Street at $1.40 (up 12% y/y), driven by a favorable mix within products as well as a favorable mix of Services revenue.
  • iPhone: December iPhone results benefitted from the timing of the latest iPhone release. iPhone revenue jumped to 59% of sales (typically around 50% of sales), up 17% y/y to $65.6B, above the Street’s $59.4B estimate (up 6% y/y). We believe that nearly $8B in iPhone revenue was pushed from the September quarter, given the delayed timing of the fall iPhone release. As a point of comparison, we believe the Street was expecting about $4B in revenue to have moved from September to December. While the timing of the latest iPhone release benefitted the December quarter, normalizing for this change, the segment’s underlying demand remains better than expected. We continue to believe the 5G upgrade cycle will be multi-year, as carrier 5G speeds improve over the next few years.
  • Services: Services revenue was 14% of sales, up 24% y/y to $15.8B, up from 16% y/y growth in the September quarter. The Street was expecting $14.8B. This shouldn’t be a surprise, given App Store revenue has seen a combination boost from increasing game revenue and the accelerating digital transformation tailwind.
  • Mac: Mac revenue was 8% of sales, up 21% y/y to $8.7B. This the only product category that came in-line with Street expectations, but was particularly impacted by supply constraints in the quarter. In March, we expect the recently refreshed Mac lineup with the new M1 chip to grow at a similar pace as the December quarter.
  • iPad: iPad revenue represented 8% of sales, up 41% y/y to $8.4B. The Street was expecting iPad revenue of $7.6B, up 27% y/y. iPad is also benefitting from the work from home and distance learning trends.
  • Wearables: Wearables, home, and accessories revenue came in at $12.9B, compared to the Street at $11.9B. The company indicated the segment has been negatively impacted by pandemic dynamics, including some store closures, and to expect that trend to continue into March. We remain optimistic that the Wearables segment (about 10% of revenue) is in its infancy. We’ll be writing more about this in the near future.

Bottom line: We applaud Apple as it navigates historic challenges facing the business, its employees, its customers, and society at large. In the face of these challenges, Apple’s business is accelerating. The company has positioned itself to benefit from the accelerating digital transformation currently underway.

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