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The Science of Hitting
The Science of Hitting
Articles (687) 

An Impressive Quarter From Apple

A look at the company's fiscal third quarter financial results

August 04, 2020 | About:

Apple (AAPL) recently reported financial results for its third quarter of fiscal 2020. For the period, revenues increased by 11% to $59.7 billion year-over-year, with constant currency revenues up 14%. As shown below, quarterly revenue growth at Apple has been all over the map in the past two years.

Year-to-date, revenues have increased by 7% in North America and by 14% in Europe, with growth in those two regions driving the 7% increase in revenues through the first nine months of the year to $209.8 billion (also helped by 9% growth in the Rest of Asia Pacific region, offset by small declines in both Greater China and Japan).

Over the same period, Apple has seen revenue growth across all of its major product categories, with iPhone, Mac and iPad growing low-single digits through the first nine months of the year. Collectively, they are up 2% year-to-date to $147.9 billion.

As Chief Financial Officer Luca Maestri noted on the call, “The record business results drove our active installed base of devices to an all-time high in all of our geographic segment and all major product categories.”

In addition to low-single digit growth for the legacy products, Apple continues to see outsized growth among its newer categories, with Wearables, Home and Accessories up 27% to $22.7 billion, along with continued growth in Services, which is up 16% year-to-date to $39.2 billion. Note that Services has delivered strong results despite some headwinds from store closures - customers like to try on products like the Apple Watch before they buy. These last two buckets - Services and Wearables, Home and Accessories - accounted for 30% of the company’s revenues through the first nine months of 2020; they’ve now reached a point where continued double digit revenue growth can be a meaningful driver for Apple as a whole.

Within that, note that Services alone accounted for 22% of revenues in the quarter. As shown below, the company has more than doubled its Services business in the past four years, from roughly $24 billion in annual revenues in 2016 to roughly $54 billion in annual revenues today.

The company now has 550 million paid subscriptions, an increase of 31% over the past year with double digit growth in each of the company’s geographic segments. In addition, as noted on the call, management expects to reach 600 million paid subs by year end.

In the first nine months of 2020, gross profits increased by 8% to $80.3 billion, with gross margins climbing 50 basis points to 38.3% on mix shift towards Services. Over the same period, operating income has increased by 7% to $51.5 billion, with operating margins unchanged at 24.6%. The drop-off largely reflects the continued impact of outsized research & development expense, which has roughly doubled as a percentage of revenues over the past five years.

Unlike most public companies, Apple has continued to aggressively repurchase its shares over the past six months. The company repurchased another $16 billion of stock in the third quarter, bringing the total for the year to $55.2 billion (consuming roughly 90% of the cash from operations generated by the business through the first nine months of the year). In the third quarter, Apple had 4,355 million shares outstanding – down more than 5% from a year ago.

The significant decline in the diluted share count, combined with the high-single digit increase in net income, has resulted in a mid-teens increase in diluted earnings per share through the first nine months of the year, inclusive of an 18% increase in the third quarter to $2.58 per share.

Amazingly, despite the fact that Apple has returned just shy of $150 billion to shareholders since the start of fiscal 2019 – an average of $21 billion a quarter – the company still ended the third quarter with more than $80 billion in net cash on the balance sheet. They’ve spoken about getting the balance sheet to “net cash neutral” for some time now; the problem is that the business is generating so much cash that they can’t give it back to shareholders fast enough.

Conclusion

Given its prodigious cash generation, the strength of its balance sheet and its willingness to continue aggressively returning capital to shareholders, I think you would be hard pressed to find a company that was more well prepared to endure any short-term headwinds presented by the pandemic. Now that we’ve seen some of the results, it’s also clear that they’ve benefited from some good fortune (most notably government stimulus), as well as shrewd decision-making in the past few years (offers like interest free financing on new devices and trade-in programs).

By my math, assuming continued outsized capital returns to shareholders and low-to-mid single digit growth in the business, I predict that Apple can earn roughly $20 per share within the next five years. That compares to a current stock price of $440 per share. While that is clearly a much higher price-earnings multiple than what Mr. Market attributed to the business five to ten years ago, I think you can also make the case that Apple has shown an ability to effectively monetize their ownership of some of the most valuable real estate in the world – the hundreds of millions of devices that people engage with hours a day - throughout the lifecycle of those devices. For that reason, I actually think that a fair amount of the change in market perception over the past few years is justified. That said, I still have no position in the stock, and do not see that changing anytime soon.

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.

Rating: 5.0/5 (3 votes)

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Comments

stephenbaker
Stephenbaker - 1 month ago    Report SPAM

Science, can't blame you for not buying the stock now, but my take is you believe AAPL is one of the best managed, profitable companies on the planet. What more could management do on behalf of shareholders? If this is not one of a very few companies that one would want to own for the long haul, then what is?

The Science of Hitting
The Science of Hitting - 1 month ago    Report SPAM

Stephen - Your point on profitabilty cannot be questioned - they are one of the most profitable companies in the world. And I think it has been very well managed as well. What more could management do on behalf of shareholders? I don't know. They've done a lot for their shareholders IMO, particuarly their aggressiveness on capital returns in the past few years. So, to your final question, is this a company I would want to own for the long haul at the right price? I think the answer is yes. I've struggled with the sustianability of the business (thinking 10 or 20 years into the future), but I could get over that at the right price and at the right size. Personally, I don't think the price is right today - but I've been wrong in the past and may continue to be wrong in the future. Thanks for the thoughtful comment!

stephenbaker
Stephenbaker - 1 month ago    Report SPAM

The problem with price and great companies is the price is always too high. Why is AMZN worth 120 times earnings? What is an appropriate price? I read and appreciate most of your posts because you analyze stocks in a way that I can understand. Yet I can't help but wonder whether many great analysts miss the idea of owning the greatest companies due to valuation metrics that may or may not be applicable. What real difference does it make when you buy companies that have a 50 year runway or more? Buffett and Munger helped drive home that concept way back when to an investor with mere average skills, at best. Made me realize that at any one time there are only a handful of companies that are truly the best in every way and made me question why own anything else for the long run.

The Science of Hitting
The Science of Hitting - 1 month ago    Report SPAM

"The problem with price and great companies is the price is always too high."

Well, in the case of Apple, the current forward P/E is somewhere around 30 times earnings. To put that number in context, the stock traded below 15 times earnings for much of the past decade. So, I'm not sure I agree with the idea that great businesses always trade at "expensive" valuations (assuming you believe Apple was a great company 3, 5, or 10 years ago as well).

"What real difference does it make when you buy companies that have a 50 year runway or more?"

If the company has 50 years of outsized growth and attractive ROIC's and ROIIC's in its future, you're right - it basically doesn't matter. The problem is that predicting the future 10 years out is difficult, let alone 50 years out. That is where an expensive starting valuation can become a real problem. If you want some examples, look at Coca-Cola's returns from the late 1990's to today, or Microsoft's returns from the late 1990's over the next 10 to 15 years.

To be clear, I completely understand what you're saying. And it's theoretically correct. But I think it's harder to do in practice. And I also think it's easier to say "price doesn't matter" when great businesses trade where they do currently; it was harder to say that a decade ago.

Just my thoughts! Thanks for the comment.

stephenbaker
Stephenbaker - 1 month ago    Report SPAM

The irony is, when Apple was trading at 15 times earnings, people were saying it was expensive. I think long runways are easier to navigate than most people think. Take MSFT as an example; even during the Ballmer years, the company's dominant position with respect to its operating system never waivered. You have to look beyond the stock price or even a few years of earnings to the precise nature of the business. Businesses that maintain a dominant position in a product or service, or preferably both, are worth owning if management allows the trajectory of the company to continue to grow - regardless of share price or temporary lags. The best companies have to be innovators and creators. Their moats have to be nearly inpenetrable and their products and services should be for all practical purposes, indispensible. How many companies qualify? In 40 years, I have found 7 such companies. I've only had to sell one - MO - back in the early 2000s when the dynamics of the tobacco industry began to permanently change for the worse. As for the rest, I've bought all at various times and valuations. Unless and until their business models become permanently impaired, there is no reason to sell, regardless of stock price. Most pay a [growing] dividend which makes the decision to hold that much easier, as well as the thought of capital gains taxes on decades of gains.

The Science of Hitting
The Science of Hitting - 1 month ago    Report SPAM

"How many companies qualify? In 40 years, I have found 7 such companies."

That is probably the most important takeaway here IMO. The list is incredibly short. And, if Apple is on that list for you, hopefully you were buying hand over fist over the past 5, 10, or 20 years. And if you were, it has worked out VERY well. Have a great day Stephen!

stephenbaker
Stephenbaker - 1 month ago    Report SPAM

Undoubtedly there have been more that smarter people than me can evaluate but I can't understand them well enough (another one of Buffett's many lessons).

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