Apple Stock: Defying The Bears Into Q2 Earnings (NASDAQ:AAPL)


The Apple Computers Store in Sydney Australia

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Investment Thesis

Apple Inc. (NASDAQ:AAPL) is slated to report its FQ2’22 earnings card on April 28, after a tumultuous quarter that saw the most massive COVID lockdowns in China since 2020. Apple stock has also been impacted as it heads into its earnings card. The market was concerned with the impact on its hardware production, given its extensive list of suppliers in China.

Despite that, AAPL stock has continued to outperform the Invesco QQQ ETF (QQQ) and its mega tech peers. We find it surprising that investors do not give AAPL sufficient credit for its robust FCF profitability, supported by an incredibly well-managed supply chain. Moreover, we think the market has also disregarded its massive stock repurchases, as Apple continues to drive tremendous shareholder value.

Given the recent retracement in AAPL stock, we discuss why AAPL stock remains a Buy heading into its earnings release.

Apple’s Estimates Revised Downwards

Apple revenue consensus estimates

Apple revenue consensus estimates (S&P Capital IQ)

Apple profitability consensus estimates %

Apple profitability consensus estimates % (S&P Capital IQ)

Given the expected moderation in its topline growth, we can understand the trepidation of some investors over AAPL stock. We have seen how such moderation has impacted other growth stocks over the past year. It has also affected Microsoft (MSFT) and Google (GOOGL) (GOOG) in the last few months. Therefore, investors have been concerned about the slowdown in Apple’s revenue growth after a remarkable performance in 2021.

Apple also saw its FQ2 and FQ3 estimates trimmed over the COVID scare in China. The company is expected to report FQ2 revenue of $94B, up 4.9% YoY. It undoubtedly represented a considerable deceleration from the 53.6% growth it posted last year.

However, we would like to point out to investors that Apple’s gross margins are estimated to remain stable, despite the moderation in its revenue growth. Notably, it’s expected to post a gross margin of 43.1% for FQ2, an improvement from last year’s 42.5%.

Moreover, its EBIT margin is also expected to remain resilient despite the supply chain and logistics snarls. Apple is projected to report an EBIT margin of 29.8% in FQ2, down from last year’s 30.7%.

Nevertheless, Apple could be further impacted in FQ3 given the recent COVID lockdowns. As a result, its EBIT margin estimates for FQ3 have been revised downwards to 28.1%. It could also be its weakest performance over the past year. Hence, we think the recent retracement in AAPL stock had reflected these potential headwinds in China, given its importance to Apple’s supply chain.

Apple FCF margins consensus estimates %

Apple FCF margins consensus estimates % (S&P Capital IQ)

Nevertheless, Apple is still expected to post robust FCF margins for FY22 at 26.9%, up from FY21’s 25.4%. However, Apple’s FCF growth could decelerate through FY23. Notably, Apple’s FCF growth estimate for FY23 was revised markedly from 10.5% to 7.5%, which could impact Apple’s stock valuation. Therefore, it’s hard to argue that the market has not reflected the macro and supply chain headwinds in Apple’s business.

But AAPL Stock Remains Reasonably Valued

AAPL stock NTM FCF yield % Vs. peers

AAPL stock NTM FCF yield % Vs. peers (TIKR)

AAPL stock YTD performance % Vs. peers

AAPL stock YTD performance % Vs. peers (Koyfin)

We can understand why some investors felt that AAPL stock is due for a significant correction. It’s clear from the second chart that AAPL stock has outperformed the QQQ, MSFT, and GOOGL stock. Therefore, the fear that the retracement could hit AAPL stock next is understandable. But investors should consider their worries in the context of its valuation.

If we consider MSFT stock as reasonably valued at 3.4% NTM FCF yield, why wouldn’t we think AAPL stock is reasonably valued at 4.1% NTM FCF yield? We must highlight that we don’t consider AAPL stock undervalued. It seems fairly valued to us, and that still makes for a compelling thesis for AAPL stock. However, we need to size our exposure appropriately (if we add), given its valuation.

Therefore, we think some investors have failed to accord sufficient credit to Apple’s tremendous FCF machine.

Is AAPL Stock A Buy, Sell, Or Hold?

AAPL stock is a Buy as it heads into its FQ2 earnings. Also, there could be another upside surprise that Apple has often used, and we have not discussed: stock repurchase.

The Street expects management to announce a sizeable buyback program that could surpass its $90B announcement last year. Trim Tabs Asset Management articulated (edited):

Apple’s free cash flow and buybacks have definitely supported the company to a larger degree than its peers. Everything is coming under pressure right now, and investors are looking for names with high-quality and sustainable free-cash-flow profitability. Apple is at the top of that list. – Bloomberg

Therefore, Apple investors could be treated to a pleasant surprise if management decides to authorize a buyback that validates our interpretation of AAPL stock valuation.

As such, we reiterate our Buy rating for AAPL stock heading into its FQ2 earnings.

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