BayFort View: Apple 3QFY22 (June end) Earnings Review

Outlook

-Revenues: All indicators point to flattening sales in the Products segment. We expect this to continue at least for the next two quarters till we pass the high base comparisons from the pandemic-fuelled purchases of CY21. However, AAPL is moving towards a more balanced products & services company. In TTM, services comprised 20% of total revenues but 33% of total gross profits, and this move towards services is likely to continue as its higher margin, almost double of products and growing at a much faster pace than products. While services growth helps with earnings, we are reluctant to give a higher valuation to the services segment as it is still linked to the growth of the iPhone ecosystem and hence hardware dependant; so at best it's a higher margin and operating leverage, consumer electronics business.?????

-EBIT: The company is moving away from a hardware-heavy sales organization to a higher margin service-driven company. Over the last three years, the contribution of services has increased from 25% to 33% (in TTM, GP). We expect an 8% CAGR EBIT between FY21-23E (September FY end). The company doesn't change investments in R&D much due to macroeconomic conditions and so as we see a slowdown in revenue growth, margins will continue to decline in the near-mid term; some of this decline in margins will be offset by a larger contribution from the higher margin and operating leverage from services segment. Higher tax rates from the AMT introduced this year in the IRA will slightly increase tax rates (14% to 16% of EBT) for Apple, thereby offsetting operating leverage from the services segment.

-EPS: We expect 10% CAGR EPS between FY21-23E (September Fiscal end). AAPL's strong cash generation allows it to do significant buybacks which could help any near-term macro-related slowdown in earnings. It will likely continue as a safe haven stock. ?

-TAM: This quarter Apple announced its Apple Pay Later credit offering. Apple keeps on introducing new streams of revenue within the Apple ecosystem of products from new services and products. However, they are all highly dependent on the continued success of Apple's consumer electronics ecosystem primarily led by iPhones. Apple's ability to command a premium over other consumer electronics companies will depend on how it converts iPhones into AR/VR devices so that it continues to dominate the consumer electronics & related services ecosystem in the next generation of AR/VR-led devices ecosystem.

-Risks: Apple has clearly won the smartphone market and is now competing fiercely in the AR/VR devices space. It will be important for Apple to also win in the AR/VR segment since phones are likely to be another service on AR/VR devices; One can't have a fully functional AR/VR device without 5G connectivity. Apple needs to win this new AR/VR segment to continue its lead in the next wave of consumer electronics transition. If we see signs of other companies winning in this space (AR/VR devices), Apple could be at risk of losing its prominence as a consumer electronics company. Finally, Apple gets a safe haven premium which if perceived to be at risk or not required, Apple could see a decline in its valuation premium. #aapl #apple

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