Apple Wavers Between Positive Earnings and Trade War Woes

Apple, Inc. (AAPL) makes a fascinating case study. The company faces China trade war threats to both its supply and distribution networks. Its flagship product, the iPhone, has been hit hard by the maturation of the smartphone replacement cycle. And yet, Apple has stubbornly held onto a buy rating, as measured by the consensus of Wall Street’s analysts. And it has done so in a time of high market volatility, despite its vulnerability to the most prevalent headwinds. It’s worth taking a deeper dive into Apple’s earnings and prospects, to see what makes it so compelling for investors.

Beating the Earnings Bears

AAPL hit a 3-month high on July 31, in the wake of a forecast-beating fiscal Q3 earnings report, and remains near that level. While overall sales were down 13% year-over-year, Apple reported quarterly revenues of $53.8 billion, just ahead of the expected $53 billion, and EPS of $2.18 compared to a forecast of $2.10. Apple-watchers breathed a sigh of relief at this; the company has been visibly struggling with a slowdown in iPhone sales for the last three quarters, and had lowered the fiscal Q1 and Q2 earnings bar before reporting. So this report, that simply beat the estimates, was a breath of fresh air.

Drilling down was better. While exact iPhone numbers are not known – the company no longer releases specific unit sales data on consumer products – a look at segment numbers shows plenty of good news.

iPad, Mac, and Wearables all brought in over $5 billion in revenue for the quarter ($5.02, 5.82, and $5.53 billion, respectively), while Services hit an all-time record of $11.46 billion, almost $2 billion more than in the year-ago quarter. iPhone revenues for Q3 came in at $25.99 billion, its lowest quarter in two years and the first time since 2012 that iPhone has made up less than half of Apple’s quarterly revenues. The gains in other segments, especially the 20% year-over-year gain in Services, indicate the wisdom of Apple’s diversification strategy to compensate for iPhone’s contraction.

Justifiably Upbeat

CEO Tim Cook gave a rosy view of the quarter and the near future, saying, “This was our biggest June quarter ever — driven by all-time record revenue from services, accelerating growth from wearables, strong performance from iPad and Mac… results are promising across all our geographic segments, and we’re confident about what’s ahead. The balance of calendar 2019 will be an exciting period, with major launches on all of our platforms, new services and several new products.”

Looking forward, Apple’s Q4 guidance forecast is for $61 to $64 billion in revenues. The next quarter is going to be an important one, as it will likely include initial subscription numbers for the much-hyped AppleTV+ and Apple Arcade services. iPhone will also be launching new models, but analysts believe the longer smartphone lifecycle will hold sales numbers down.

Speedbumps from Trump

The good vibe didn’t last long. Just two days after the Q3 report came out, President Trump opened a new round in the US-China trade tensions, tweeting that the US will impose a 10% tariff on some $300 billion in Chinese import goods starting September 1.

The new tariffs will directly impact Apple’s supply chain and production costs. Recognizing the dangers that tariffs pose to its business, in July Apple unsuccessfully lobbied the Administration to exempt components of the Mac Pro from the tariffs. The company went so far as to claim that, rather than being protective in nature, the tariffs will necessitate price increases in compensation and will “tilt the playing field in favor of our global competitors.”

Markets declined generally in the first few days of August, responding to Trump’s tweet and China’s retaliatory move in devaluing the yuan. Apple shares lost their post-earnings gain and bottomed out on August 5 after slipping 9.2%. AAPL, and the markets generally, have made gains in recent sessions as investors and China watchers hold back judgement on the tariffs; President Trump is notoriously mercurial, and earlier this year canceled threated tariffs after productive negotiating sessions.

Checking in with Analysts

Wall Street is generally optimistic about AAPL’s prospects. Writing after the quarterly report, Tom Forte from D. A. Davidson (a 5-star analyst according to TipRanks), said, “While iPhone revenue contracted from last year, the sequential improvement was better than expected. We are also positive on Apple's Services revenue growth as a sign that the company is diversifying its business away from smartphones…” Forte boosted his price target on AAPL from $245 to $270, suggesting an upside of 34% for AAPL shares.

Wedbush analyst Daniel Ives (a 4-star analyst) is also bullish on Apple. In his comments on the quarterly earnings, he wrote, “Overall, we would characterize this quarter/guidance as a major feather in the cap for the bulls that should drive the stock to new highs over the coming months…” Ives’ price target of $245 indicates a 21% upside potential.

Finally, Wamsi Mohan (a 4-star analyst) of Merrill Lynch sees the stock’s recent slip as a chance to pick up AAPL. He points out, “In the broader context of the tailwinds that AAPL has, we view this as a relatively small amount over the next several quarters and would use the pullback as an especially attractive opportunity to buy shares of Apple…” Along with his buy recommendation, Mohan gives Apple a $240 price target, suggestive of a 19% upside to the stock.

Despite the headwinds Mohan referred to – the slowing iPhone sales, increased competition in China from cheaper domestic products, the prospect of increased tariffs impacting product prices – Apple still keeps that Moderate Buy from the analyst consensus. The rating is based on 15 buys, 11 holds, and 2 sells given in the past three months. Apple is trading for $200 and has an average price target of $221, giving AAPL shares a 10% upside potential.

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Disclosure: This author is long on AAPL.