Apple will report June quarter results on Thursday, July 30th. The June quarter will be messy for all companies, including Apple, with revenue and earnings likely down around 10% y/y. While the numbers will be noisy—magnified by the fact that neither the company nor many of its peers provided guidance citing market uncertainty—we expect the June quarter results to instill confidence that the company will return to its growth curve next year. Investor confidence will be based on Apple’s strong cash position and commentary about upcoming products that tap into long-term undeniable growth movements (5G, digital health, working and learning from home, services, and autonomy).
While 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 beyond in the years ahead.
Key June metrics:
- Cash: Apple ended the March 2020 quarter with $193B in total cash including $110B in debt, or $83B in net cash. We expect total cash at the end of June 2020 to be $185B including of $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—they can expect in the years ahead an additional $83B 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 that the road to net cash neutral is long and slow. Apple has generated $57.2B in net income over the past four quarters and returned $90.4B in capital, or net $33.2B 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.
- Revenue: We expect revenue of $49.5B (down 8% y/y) compared to the Street at $51.9B (down 4% y/y).
- Earnings: We expect EPS of $1.92 (down 12% y/y) compared to the Street at $2.02 (down 7% y/y).
- Guidance: When the company reported March quarter results they did not provide guidance. We don’t expect guidance for the Sept. 2020 quarter.
- iPhone: We expect iPhone revenue (42% of sales) to be down 20% y/y to $20.8B, below the Street’s $22.2B estimate (down 15% y/y). We believe the company will hint that its annual fall iPhone release is largely on track.
- Services: We expect Services (27% of sales) to be up 18% y/y to $13.5B, in line with 17% y/y growth last quarter. We are not clear on the consensus estimate for Services revenue; we believe investors are hoping for similar growth compared to the March quarter.
- Wearables: We expect wearables (10% of sales) to be up 15% y/y, compared to up 44% last quarter. Apple does not report this metric but frequently comments on the segment’s sales trajectory.
- Mac: We expect Mac revenue (9% of sales) to be down 20% y/y to $4.7B.
- iPad: We expect iPad revenue (9% of sales) to be down 15% y/y to $4.4B.
Some perspective on the June quarter
The June quarter falls within a once-in-a-lifetime event (we hope). Traditional metrics (sales, units, ASPs, gross margin) are less relevant given this historically different period. The June quarter is an opportunity to look for relevant information about Apple’s current strength, future prospects, and true intrinsic value.
In the past, we have referred to this period as the National Pandemic Adjustment Period, coined by St. Louis Federal Reserve President James Bullard. During this period we intentionally shut down major swathes of our national and global economy to achieve national health objectives. Similar to the March 2020 quarter, what occurred in the June quarter should be viewed as an aberration, both in positive and negative terms. To try and apply traditional norms, measures, and metrics is of limited value.
Financial strength can be gleaned from June results
First, an update about the most important metric at the moment, the company’s balance sheet and ability to generate cash. At the end of the March quarter, Apple had $193B in total cash on hand ($83B in net cash after debt). Over the last six quarters, since they announced plans to be net cash neutral over time, net cash has declined on average $9B per quarter. We expect net cash will be down about $10B in the June quarter as the company makes progress towards net cash neutral. That implies ending the June quarter with $75B in net cash and near $180B in total cash.
Financial strength is a key indicator of how any company will navigate the path out of this difficult period to the destination of the new normal on the other side once the pandemic has passed.
March quarter showed Apple is successfully weathering the storm
Apple was the most at-risk large US tech company for reporting a disappointing March quarter due to the company’s hardware businesses and exposure to China. Given these headwinds, reporting 1% revenue growth was a win and is representative of the strength of Apple’s presence in our lives. The company also increased the share buyback by $50B, which is unprecedented in the face of lower revenue visibility over the next several quarters. What was lost in March earnings was the significance of the measures the company is taking to manage the business for long-term revenue growth and profitability. That means Apple is continuing its previous product release schedule along with plans to invest in future products and services. This approach will likely yield a stronger product roadmap versus other competitors and larger growth opportunities in 2021.
The months ahead should favor Apple
The months ahead will have many unknows. What we do know is that Apple entered the pandemic strong, and today the company’s products are an even more foundational part our lives as we work, live and play from home.
The long-term path to AAPL at $500 and beyond
2020 is an unknown. However, the powerful trends that were in place within technology, media, and health will still be in place when this period of uncertainty 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 what we expect is $185B 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 sharp contrast to Apple and Amazon’s valuation
Amazon is an inspiring company, taking its leadership position in online retail and cloud solutions and funneling those profits into innovations around the future of delivery, brick and mortar commerce, and gaming. Similar to Apple, Amazon runs its business for the long term. However, from a valuation perspective, investors view the two companies differently.
Over the past four quarters, Amazon has reported net income of $10.6B compared to Apple at $57.2B. Despite the fact that over the past year Apple reported net income more than 5x greater than Amazon, both companies share a similar ~$1.55T market cap. While the past is not an indicator of future performance, we believe this discrepancy illustrates a climate of muted investor optimism for Apple compared to Amazon. We expect Amazon will continue to be successful. At the same time, we expect Apple to report results that will surprise investors to the upside as the company emerges from the pandemic even better positioned to return to its long term growth curve.
Tesla’s profitable June quarter and likely addition to the S&P 500 will be the central takeaway from its most recent earnings report—and a long-awaited acknowledgment from the investment community that Tesla will survive. That said, we believe the most important takeaway is that Tesla is following Amazon’s playbook: building a virtuous cycle of reinvesting profits to drive growth, scale, and innovation. Tesla’s valuation will likely have wild swings in the future and move higher over time, similar to Amazon’s trajectory.
Bad news for the auto industry
Musk commented during the earnings call that the company’s operating margin goal is to be slightly profitable and maximize market share. That means, similar to Amazon, they will pass the majority of upcoming cost savings from manufacturing efficiencies to consumers in the form of lower-priced vehicles. We expect it will continue to be difficult for other carmakers to build a vehicle that is feature and price competitive with Tesla. The company currently has about 80% EV share in the US, and it’s getting more difficult to imagine material changes to US market share in the next couple of years.
More than an auto company
While Energy Generation and Storage is only 6% of Tesla revenue, Musk surprisingly made several references on the earnings call to the importance of solar and batteries, reiterating the company’s mission to accelerate the world’s transition to sustainable energy. We see the company slowly adding energy as a central theme to the story, with details to follow at Tesla’s Battery Day event (currently scheduled for late September). Similar to Amazon, we believe the long-term value of Tesla will not lie in its initial business; rather, the long-term value will include renewables, batteries, and repurposing those technologies into new markets, potentially HVAC, small aircraft, and others.
June quarter takeaways:
- The company reported a profit partly driven by EV tax credits of $428m, up from $354m last quarter. Zach Kirkhorn (CFO) predicts 2020 regulatory tax credit revenue will be roughly double that of 2019. This implies a drop to ~$200M average in Sep-20 and Dec-10, a significant step down from the first half of the year. We expect EV tax credits to continue to trend down in 2021, eventually to zero. Profitability was also driven by Model Y’s gross margin along with FSD revenue.
- Auto margins are becoming more sustainable, which gives the company room to continue to lower prices and gain market share. Auto gross margin excluding EV credits was 18.7%, ahead of the Street at 17.3%, down from Mar-20 at 20%, and in-line with Dec-19 at 18.9%.
- The company recognized $48m in FSD revenue. We expected the number to be slightly higher, which means there is still meaningful deferred revenue to recognize, likely more than $500m.
- The next Gigafatory will be in Austin, TX. We expect car production to commence sometime late in 2021 or early in 2022. Austin, in combination with Berlin and the ramping production in Shanghai, means the company will have three new automaking facilities in the next 18 months. Looking out over the next decade, the actual number of factories will become less important, with greater importance on total output. Musk declined to comment on the Austin factory’s expected output, but we expect it to be measurably higher than Fremont’s production capacity.
- Tesla is standing by its 500k delivery target for 2020. The company reiterated its target for the first time in 6 months, saying that they still believes they can deliver half a million vehicles in 2020.
Tesla reports June quarter results on Wednesday, July 22. The most important take away from the earnings results will likely be the company turning a slight profit and achieving positive free cash flow. This would pave the way for Tesla likely to be added to the S&P 500 within two months. We expect shares of TSLA to continue to see big swings in the months ahead but generally move higher as the company advances the future of EV’s, autonomy, and energy. Here’s what we’re looking for in the June quarter results:
The most important metric, deliveries, was already reported. The company delivered 90,700 vehicles in June, down 5% year-over-year (vs. 95,200 in Jun-19), compared to GM down 34%, Toyota down 35%, and Fiat Chrysler down 39%. During that time the Fremont factory (60% plus of overall production) was shut down for 33 days.
While the Street is expecting a loss, most investors now believe the company will report a profit. We anticipate Tesla will report a profit based on the following 6 factors.
- Regulatory tax credits. In Mar-20 the company sold $354m in EV credits, compared to $133m in the Dec-19 quarter. We believe given the Fiat Chrysler agreement to purchase additional credits, we expect between $200-$300m EV credit revenue in Jun-20.
- FSD. The company added stop light and stop sign detection in June, which will allow them to recognize a portion of deferred full self-driving revenue. Beyond the revenue recognition, Tesla stoked FSD demand by lowering the upgrade cost of FSD for former buyers who opted out at the time of purchase and telegraphed an FSD upgrade price increase for those same customers on July 1st.
- High margin Model Y trims. In March Tesla sold about 2k Model Y’s, going to about 15k in June. Most of these were higher margin performance and long-range battery configurations. This is a similar phenomenon reported in Sep-18 with high margin Model 3 trims. Additionally, in July Model Y got a $3,000 price reduction, which we read as evidence that Model Y manufacturing efficiencies are improving quickly.
- Gigifactory Shanghai margins. In March we believe the company made about 15k units in China and that increased to about 30k in the June quarter. An increase in Shanghai production should lay the groundwork for better margins in China.
- Pandemic cost-cutting. These changes were announced earlier in the year, and it’s unclear when the timing of the cost reductions will impact the bottom line.
- Panasonic battery renegotiation. At the start of the June quarter, Tesla renegotiated its supplier agreement for Panasonic 2170 battery cells. We don’t have a line of slight into the exact timing of the likely price break and believe it could have already started in the June quarter.
Auto gross margin ex-credits
We expect auto gross margins near 20%, essentially unchanged from the March quarter, and above consensus of 17.3%.
Free cash flow
We expect the company will report positive free cash flow for June based on three factors. First, 8,400 more vehicles were delivered in June than produced. Second, there is the potential for greater than expected cash flow benefit from regulatory tax credit revenue. Lastly, in the March quarter, Tesla increased its work in process and raw materials due to the pandemic disrupting production. These parts were paid for in March and should have a positive impact on free cash flow in June.
Three outstanding questions
- Will Elon reaffirm his previous target of 500k delivers for 2020? In March he did not reaffirm the annual deliveries target; rather, he said they expect to have the capacity to produce 500k vehicles this year.
- When will we see Model S/X updates? Recently the company reduced the price on S/X models by $5k, suggesting updates are getting closer.
- How will Tesla discuss energy-related opportunities? The energy aspect of the Tesla story is under-appreciated by investors. We will listen for commentary related to the long term opportunity around solar and batteries.
- Will the company capitalize on the surge in market cap and raise money?