Friday, May 1st 2020

Apple Q2 Earnings Analysis: Services and Wearables drive revenue growth


On Thursday after hours, Apple fell 3% despite soaring past analyst expectations on both revenue and EPS (by +6% and +14%, respectively).

We believe this was mostly due to disappointment at the company's decision to not provide guidance for fiscal Q3, which was quite understandable in our view.

Without Q3 guidance, we believe it will be difficult for analysts to form a tight range of estimates, increasing the relative uncertainty around the next quarterly print.

Consensus estimate ranges for Q2 were already quite wide, so we understand why this investors would want more clarity there, but from a fundamentals standpoint we don't think the decision to withhold guidance has a material read-through.

Overall, we saw Apple's fiscal Q2 as being remarkably strong given the macro backdrop, with iPhone sales appearing far more resilient than we would have expected, and strong Wearables and Services performance powering total company revenues to actually grow vs. the prior year's quarter.

Our main takeaways from the quarter are below:

1.) Like Google and Facebook, the March quarter represented a "tale of two quarters" for Apple

  • Apple was on track to book a record second quarter near the high-end of its expectations at the beginning of Q2
  • Business experienced a sharp drawdown during the last 3 weeks of the quarter but has since rebounded in April, echoing similar observations recently made by Facebook's management team
  • While sales slowed down in March due to widespread store closures, demand was actually stronger vs. the same time the prior year as channel inventory drew down at a faster pace

2.) The iPhone and broader Apple ecosystem remain very healthy

  • iPhone revenues were only down -7% year-over-year despite the dramatic slowdown in economic activity and widespread Apple Store shutdowns
  • Moreover, Apple's "installed base" reached all-time highs across all major product categories and regions. This is a key metric that loosely represents the total number of active Apple devices in use around the world, and represents the aggregate monetization potential Apple has at its disposal
  • Consumer satisfaction with the flagship iPhone models (the 11, 11 Pro, and 11 Pro Max) continued to remain high, coming in at an impressive 99%

3.) Strength in Services and Wearables sales powered Apple to net revenue growth over a very difficult quarter

  • Wearables and Services both grew revenue by +23% and +17% respectively in Q2, allowing Apple to drive positive revenue growth over the very difficult March quarter
  • In fact, in Services, year-over-year growth actually accelerated vs. the prior quarter, largely driven by strength in paid subscriptions, which grew at the fastest quarter-over-quarter rate the category has seen in its entire history
  • Paid subscriptions on the Apple platform now total 515 million, suggesting the company is well on its way to hitting its previous 600 million paid subscription target by year-end
  • The Wearables segment - a business we recall many investors viewing as an mere afterthought not too long ago - is now generating as much revenue as many entire companies in the Fortune 200 (for example, Tesla, Qualcomm, and Gilead)
  • Smaller product categories like Watch and iPad/Mac still seem underpenetrated with plenty of room for category growth, with 75% and 50% of Watch and iPad/Mac purchases in fiscal Q2 coming from first-time buyers of those products

4.) Despite lack of formal guidance issuance, financial outlook from here remains strong

  • In a strong demonstration of its financial strength, Apple increased its dividend +6% and added $50 billion to its share repurchase authorization, highlighting both the offensive and defensive value of Apple's famously large (currently bordering on $200 billion) cash balance
  • Over the next quarter, we expect further acceleration in iPad and Mac sales as iPhone and Wearables sales decelerate.
  • Services performance is likely to be mixed, with growth in subscription and App Store revenues expected to be offset by a slowdown in AppleCare and advertising revenues
  • The company plans on reopening several Apple Stores across the US in the first half of May, potentially setting itself up to maintain the trend towards stabilization witnessed in the back half of April
As of this writing, AAPL was a portfolio holding of Titan. This security may cease to be a portfolio holding at some point in the future.
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