Nikada
Introduction
Back in early January this year, I issued a rather bearish article on Apple Inc. (NASDAQ:AAPL) outlining a clear disconnect between the price and value. At P/CF of ~29x, one should expect attractive prospects for further value creation and growth. However, the “China factor,” flattish top line, and peaking valuations render the story of multiple justifications quite difficult.
Now, on February 1, 2024, Apple circulated its Q1, 2024 quarterly earnings report (covering the final quarter of the 2023 calendar year), which brought a mixed bag of messages and signals to the market.
While there are some positive indications here, the overall situation strengthens the approach of being extremely cautious with this company and even considering trimming down the position as much as possible.
In this article, I will dissect the Apple fiscal Q1 earnings report and provide my take on this in three levers: the good, the bad, and the ugly.
The Good
You have to give credit where credit is due, and in this case, it lies in two aspects: (1) sales growth; and (2) margin expansion.
Even against the challenging backdrop in the geopolitical front and difficulties in the China market, Apple managed to register slightly higher sales figures in Q1 2024 relative to Q1 2023 comparable. This has happened despite a $3 billion decrease in the sales to Greater China geography, which in turn means that the Company has managed to find additional pockets of revenues to compensate for this gap and deliver an additional $2 billion on the Q1 2024 top line.
According to Luca Maestri, Apple’s CFO, another reason behind the solid growth in the underlying EPS figure was the progress with margin optimization:
Our December quarter top-line performance combined with margin expansion drove an all-time record EPS of $2.18, up 16 percent from last year
In fact, improving margins was the main fundamental driver for the Y/Y increase of 16% in Apple’s bottom line, as it can be quite clearly implied from the 2% sales growth over the TTM period.
The Bad
The flip side of the aforementioned dynamics is that the outlook for further advancement is quite discouraging.
Let me explain.
We have to zoom back a bit to December a year ago (2022) when Apple was forced to deal with a constrained supply chain that limited the Company’s ability to fully satisfy the pent-up demand from COVID-19 and in general from “wealthier” consumers due to the fiscal support effects.
What this did is that it temporarily inflated Apple’s cost base and created pressure on the margins that ultimately led to a rather biased end result, which in turn made the subsequent periods easier in relative terms.
In other words, we have to factor in that the rate of change in the margin front has been greatly supported by a favorable comp base.
With fiscal Q1 2024 coming in, the total gross margin figure landed at 45.9%. If we contextualize this against the projections for 2024 (calendar period), the picture is not that rosy (to say the least).
According to Luca Maestri (as per the latest conference call), the gross margin is set to remain flat:
We expect gross margin to be between 46% and 47%. We expect OpEx to be between $14.3 billion and $14.5 billion. We expect OpEx to be between $14.3 billion and $14.5 billion
Plus, the estimate for OpEx signals no major enhancements in the admin cost end.
Finally, we have to factor in Apple’s struggles with iPhone sales in China, which has continued to deteriorate quarter by quarter.
Here, we should be concerned not only about the drop in volumes, but also the effects on the profitability of these declining revenues.
As is usually the case, whenever a specific product starts to show signs of falling out of vogue, you have to offer discounts to halt the negative movement. This is what Apple has already initiated, but as Q1 2024 indicates, it is not that easy to reverse this trend.
So, the increased competition from the likes of Xiaomi, Huawei, Samsung and others have clearly proved that Apple’s premium product has slowly but surely lost its attractiveness in the eyes of Chinese consumers, which together account for ~20% of AAPL’s sales (this has to be obviously viewed in the rate of change terms, which is what matters for value creation).
The Ugly
Now, the ugly truth is that the “good” side of this story is nowhere near of being good enough to justify the current multiples, which if measured by Apple’s cash generation stands at 29x (in P/FCF terms).
It really boils down to the combination of the following factors that make the investment case highly unattractive for investors at the current valuation levels:
- Stagnating sales growth.
- One of the key historical sales drivers continues to impose significant headwinds for the overall business.
- Largely exhausted potential for further margin optimization.
- Future growth drivers (e.g., Vision Pro) are at a very infant stage with still no clear understanding of the extent of the incremental value creation.
- Increasing tensions in the geopolitical landscape, which inherently put downward pressure on Apple’s cash flows from volatile FX, cost inflation (e.g., higher logistic costs and potential risk for new tariffs) and in general less favorable environment in which to plan long-dated CapEx.
And the fiscal Q1 2024 results confirm just that.
The bottom line
The results from the Q1 2024 earnings report have strengthened the argument of a prevailing disconnect between the underlying fundamentals and the share price. At a P/FCF of ~29x, we should expect at least several favorable growth drivers in the near horizon. Yet, as the recent figures confirm, the growth prospects seem to be quite depressed from the still deteriorating sales in the Chinese market and an exhausted potential for further margin optimization, as also indicated by the communicated guidance and Apple’s battle with the product pricing in the Chinese market just to shield the current market share.
Once again, investors have to be very careful with Apple and consider all of these variables, which to me signal an elevated probability of the stock turning out to be overpriced against the underlying essence.
In a nutshell, I recommend avoiding Apple, Inc. stock at these multiples when the key growth (and value creation) engines are running out of steam. At the same time, I would stay away from going short the stock given its presence in the Magnificent Seven bag, which is by definition largely influenced by the passive flows and factors that are not always associated with the underlying financial substance. Plus, given the recent bet on the Vision Pro product, which might also turn out to be a successful one, there is a notable probability of the market sending the stock price higher from here.
So, for me, Apple stock is a hold.