Apple (AAPL) on July 30 reported financial results for the third quarter of fiscal 2019.
For the period, revenues increased 1% to $53.8 billion -- a notable improvement from the mid-single digit revenue decline that the company reported in the first half of the fiscal year. That 1% growth in the third quarter was inclusive of a 300 basis-point headwind from foreign exchange, with constant currency revenues growing in each of Apple’s five reportable geographies.
Most notably, the company saw a material improvement in its Greater China business, with revenues down 4% in the third quarter compared to a 27% decline in the first quarter and a 22% decline in the second quarter.
The trend improved for the company’s most important product as well: iPhone revenues were down 12% in the third quarter, compared to a 16% decline in the first half of the fiscal year.
As I noted last quarter, it sounds like some of this improvement was attained by cutting prices in China to try to stoke demand (along with similar actions in India). Here’s how CEO Tim Cook put it on the conference call:
“I'd like to provide some color on our performance in Greater China … We experienced noticeably better year-over-year comparisons for our iPhone business there than we saw in the last two quarters and we had sequential improvement in the performance of every category. The combined effects of government stimulus, consumer response to trade-in programs, financing offers, and other sales initiatives and growing engagement with the broader Apple ecosystem had a positive effect. We were especially pleased with a double-digit increase in services driven by strong growth from the App Store in China.”
The fact that management felt the need to implement these actions speaks to a competitive environment in regions like China that is different than what they have faced domestically. These changes appear to have had the desired effect, at least in the short term.
The active installed base of Apple devices reached a new all-time high, with year-over-year gains in each region and product category. This was a primary driver of continued growth in the Services business (up 18% in constant currencies to $11.5 billion). The company now has 420 million paid subscriptions, up from 390 million at the end of the second quarter; over the past two years, the number of paid subscriptions has more than doubled.
Broadly speaking, Apple is seeing success beyond its smartphone business. Excluding the iPhone, revenues increased 17% in the quarter, with Mac up 115 and iPad 8%. Wearables, Home and Accessories increased nearly 50% on accelerating growth from Wearables.
Despite higher revenues, outsized growth in expenses (particularly research and development) and mix shift away from high-margin iPhone sales led to an 8% decline in operating income. As shown below, despite a roughly four-fold increase in run rate revenues since fiscal 2010, Apple is currently investing a much higher percentage of its revenues into research and development:
Higher interest expense attributable to incremental debt led to an additional headwind on the bottom line, with net income declining by roughly 13% in the quarter. The share count declined by roughly 7%, resulting in a mid-single digit decline in earnings per share. Year to date, earnings per share have declined by roughly 1% to around $8.9 per share.
Apple returned $21 billion to shareholders in the quarter, with $17 billion allocated to share repurchases. They also spent $3.6 billion on dividends, with a current quarterly payout of 77 cents per share (at $193 per share, the dividend yield is 1.6%). Through the first nine months of the fiscal year, cash flow from operations was $49.5 billion. Against these cash outflows, Apple has spent $7.7 billion on capital expenditures, $10.6 billion on dividends and $49.5 billion on repurchases.
The company ended the third quarter with $211 billion in cash and marketable securities, compared to $108 billion in total debt. That leaves Apple with $103 billion in net cash, or roughly $22 per share. After a few years of somewhat limited action (in terms of returning the company’s prodigious cash flow to shareholders), it now appears that management is serious about bringing the balance sheet to a “net cash neutral position” in a reasonable amount of time.
Conclusion
As I’ve noted in the past, a material component of the Apple investment thesis is tied to capital returns. The company is likely to return over $300 billion to shareholders through repurchases in the five-year period through fiscal 2023. The effectiveness of those repurchases will depend on what the stock price does over that period; $300 billion of repurchases at $125 per share has a much larger impact than a comparable amount of repurchases at $225 per share.
By my math, which assumes that the stock trades at a forward price-earnings multiple roughly in-line with where it is currently, Apple will earn around $17 per share in five years.
At this point, Apple isn’t cheap enough for my liking. If it fell materially from current levels without any impairment to the earnings power of the business, that would be a good thing for long-term shareholders. It would also lead me to reconsider an investment in Apple. We’ll see if Mr. Market decides to put the stock on sale (again).
Disclosure: None.Ă‚
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