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The Science of Hitting
The Science of Hitting
Articles (656) 

Apple: Navigating the Pandemic

Some thoughts on the company's second quarter results

May 07, 2020 | About:

Last week, Apple (AAPL) reported results for its second quarter of fiscal 2020.

Following a strong first quarter, in which revenues increased by 9%, Apple saw a material slowdown in its top-line growth rate, with revenues up roughly 1% from the year ago period (and up roughly 2% in constant currencies). As CEO Tim Cook noted on the conference call, this deceleration reflected the impact of three distinct phases that the company experienced in the quarter:

“Based on Apple’s performance during the first five weeks of the quarter, we were confident we were headed toward a record second quarter at the very high end of our expectations [double digit growth]. In the next five weeks of the quarter, as COVID-19 started impacting China, iPhone supply was temporarily affected, as well as demand for our products within China. This caused us to withdraw our revenue guidance in February. At that point, demand for our products outside of China was still strong and in line with our expectations. During the last three weeks of the quarter, as the virus spread globally and social distancing measures were put in place worldwide, including the closure of all our retail stores outside of Greater China on March 13th, and many channel partners around the world, we saw downward pressure on demand, particularly for iPhone and Wearables.”

By my estimations, this suggests that revenues declined precipitously in the last three weeks of the quarter, potentially by somewhere in the range of 30% to 40%.

From a geographic perspective, the Americas and Greater China both reported lower revenues than in the year ago period, with those results reflecting a significant deceleration from the trend in the first quarter. The same was true for iPhone globally. Following 8% growth in the first quarter, iPhone revenues declined by 7% in the second quarter year over year, with supply and demand impacted by the pandemic.

These headwinds were offset by continued growth in services (+17%) and wearables, home and accessories (+23%). Collectively, the non-iPhone portion of Apple’s business increased revenues by 9% in the second quarter, compared to 11% growth in the first quarter.

As CFO Luca Maestri noted on the conference call, services continue to be a bright spot for Apple:

“We set an all-time revenue record of $13.3 billion with strong performance across the board and all-time revenue records in the App Store, Apple Music, Video, cloud services, and our App Store search ad business… As Tim mentioned, we’re well on our way to accomplishing our goal of doubling our fiscal 2016 Services revenue during 2020.”

The active installed base of Apple devices reached another new all-time high in the quarter, with growth in every geographic segment and product category. The company now has roughly 515 million paid subscriptions, an increase of more than 30% over the past year, along with the goal of crossing 600 million paid subscriptions by the end of calendar 2020.

The low-single digit increase in revenues was outpaced by expense growth, most notably research & development costs (up 16% year-over-year). As a result, operating income declined by 4% to $12.9 billion, with margins contracting 110 basis points to 22.0%. Through the first six months of the year, operating income has increased by 5% to $38.4 billion.

Net income declined by an amount comparable to operating income (down 3% to $10.3 billion), with diluted earnings per share increasing 4% due to a significant reduction in the share count.

In the second quarter, Apple allocated $18.5 billion to share repurchases, which were executed at an average cost of $286 per share. Through the first half of the fiscal year, Apple has allocated more than $39 billion on repurchases (21% more than they spent in the first half of fiscal 2019).

As shown below, the hundreds of billions of dollars that Apple has committed to repurchases over the past decade have resulted in a roughly one-third reduction in the share count.

Apple currently has $83 billion in net cash, or roughly $19 per share. Slowly but surely, the company is making progress towards their long-term objective of a net cash neutral position.

Conclusion

Given its prodigious cash generation, along with the strength of its balance sheet, you would be hard pressed to find a company that is more prepared to endure the pandemic than Apple, in my opinion.

That said, I continue to believe that Mr. Market’s optimism fully accounts for economic reality at current levels, and given the fact that the company will spend hundreds of billions of dollars on repurchases over the next three to five years, that’s a negative for long-term shareholders as well. Put differently, it would be beneficial for potential and current shareholders if the stock traded much lower over the interim.

That's not the case currently, so for now, I will stay on the sidelines.

Disclosure: None

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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