Apple’s Underappreciated Resilience

Apple’s Underappreciated Resilience

Apple reported June quarter results essentially in line with expectations and guided Sep-19 revenue about 5% ahead of the Street. These results and guidance are impressive given the company’s China, macroeconomic, and competitive headwinds.

This quarter is evidence that Apple’s ecosystem has a steadying effect on the overall business, an attribute that is underappreciated by investors, leading to a lower-than-deserved multiple. We believe this quarter’s results and the roadmap for the next two years will prove to be a turning point for investors to begin valuing Apple with a more appropriate multiple.

  • Most impressive from the Jun-19 results was the rebound in Greater China, which accounted for 17% of revenue, up from 13% in Mar-19 and 16% in Dec-18. The company attributed the rebound to taking a more active role in stimulating demand with more generous trade-in programs. While this is effectively a price reduction, it is likely modest, and the right thing to do considering the region’s competitive dynamics.
  • Services revenue was up 13% y/y vs. expectations of 15% y/y. Adjusting for last year’s one-time litigation benefit, Services would have been up 15% y/y. Note that the Street was aware of that one-time benefit when estimating this quarter’s revenue. Despite this “miss,” we view this quarter’s Services revenue as essentially in line, as investors are satisfied with the overall trajectory of Services growth (12%-16% range). Separately, it appears that Services growth is slowly decoupling from hardware growth, a positive indication that Apple is reaping the rewards of its large installed base.
  • The biggest surprise was that Sep-19 guidance came in about 5% ahead of the Street (assuming a typical quarter where they hit the high end of revenue guidance). This equates to 2% y/y revenue growth, reversing the previous three quarters, which were down 2%, 5%, and 5% respectively. Adding to the significance of the guidance was the September quarter’s difficult +20% comp vs. the just-reported quarter’s +17% comp.
  • With the September guidance out of the way, we are focusing on the easier comps, which measurably de-risk quarterly results and guidance through Sep-20. Our view that we have entered smooth sailing until the 2020 iPhone cycle will be countered with concern that iPhone will miss expectations as consumers hold off for a 5G iPhone. We see that view as largely irrelevant, as the vast majority of consumers that hold off this cycle will likely pay more for an iPhone in 2020.

The Street Has Apple’s Multiple Wrong

We believe the Street is systematically undervaluing Apple’s ecosystem by focusing on hardware sales instead of revenue and earnings growth plus optionality. This weighs heavily on the stock’s multiple. The rebound in Apple’s China business along with Sep-19 guidance, which calls for a return to growth, should be a catalyst for Wall Street to reconsider the prevailing wisdom that Apple should trade between a 13x and 17x multiple because they are a hardware business.

Apple trades at a 24% discount to Facebook (21x multiple) and a 71% discount to Amazon (56x). Keep in mind, in the most recent quarter, Apple earned 2x more than Facebook and Amazon combined and has over a billion daily active users. Additionally, Services accounted for 21% of revenue and 36% of gross margin dollars this quarter. This begs the question: why does Apple trade at a significant discount to the rest of FAANG? Our answer: It shouldn’t be.

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