Apple (AAPL) is scheduled to report the results of its fiscal 1Q20 on January 28, after the closing bell. Needless to say, all the attention of the financial community will be turned to Cupertino, California. The tech and consumer goods company is expected to deliver revenue growth of nearly 5% over very easy 2018 comps, while EPS is forecasted to improve YOY by about 9%. Both estimates sit a hair above the midpoint of the guidance range that the management team communicated three months ago.
I, on the other hand, think that Apple can do better.
Credit: Live Trading News
What to expect
Two crucial and related topics of discussion will likely take center stage on Tuesday: iPhones and China. The flagship product category, which still accounted for a bit more than half of total revenues in fiscal 4Q19, is largely to blame for Apple’s loss of top-line firepower over the past several quarters. And China, facing multiple challenges that range from the trade war with the US to social and political distress in Hong Kong, has been a particular sore spot for the Cupertino-based company.
At the risk of sounding overly optimistic, the 2019 holiday season could mark the beginning of a turnaround in the smartphone segment. This is not to say that handheld devices will turn back the clock and exit the maturing and early declining stages of the product life cycle, or that the Greater China market will finally regain its former glory. But given the lapping of a nearly disastrous 2018 holiday season, I believe that Apple has seen the worst of the deterioration in its phone business.
Case in point, the early success of the iPhone 11 cycle seems to be all but a consensus by now – see graph below, depicting the popularity of the new devices, as reported by Apple Insider. In line with my September analysis, I believe credit should be given to Apple’s strategy to make the new models more accessible to the masses. As a reminder, the company has introduced in-store trade in and financing programs, in addition to lowering the price of the lower-end model (plain iPhone 11) by $50 compared to the previous year’s iPhone XR that it replaced.
Source: Apple Insider
But consistent with my recent arguments, I don’t believe that fiscal 1Q20 will be all about the iPhone. I expect the wearables segment to impress once again on the back of a refreshed Apple Watch that debuted just before the start of the quarter. I continue to believe that the watch will be an underappreciated generator of top- and bottom-line growth in the foreseeable future, and still project that at least one-third to one-fourth of Apple’s total company consensus revenue growth in fiscal 2020 will come from this product category.
Importantly, I also believe that AirPods have the potential to be the “unsung hero” of the holiday season. Estimates suggest that Apple has dominated the wireless headset space in 2019, having sold 60 million devices in the period. Due to the parabolic growth of this product category, I would not be surprised to see sales being disproportionately concentrated in the last quarter of the calendar year, perhaps reaching $5 billion (roughly 25 million units times an ASP of $200, aided by the launch of the higher-end AirPod Pro in October). For reference, all of Apple’s wearables division produced $7.3 billion in revenues in fiscal 1Q19.
Source: D.M. Martins Research, using data from company reports
Lastly, margins will probably depend on how well the services segment has performed in fiscal 1Q20. As a reminder, services are about twice as profitable as products, on a percentage-of-sales basis. While I have no reason to believe that growth in service revenues will falter, the segment has experienced a few lumps in performance in the past couple of quarters – see graph above.
Still a high-conviction bull
Taking a step back, I continue to be an AAPL bull. I believe the company is riding the tailwinds of increased consumer spending in wearables and other tech devices outside the smartphone category, while doing a competent job at monetizing its enormous installed base. I believe that fiscal 1Q20 earnings will confirm my optimism towards the company and its business prospects.
Having said the above, I also doubt that this stock will experience the same levels of market value growth that it did in 2019. While I believe that the valuation multiple expansion of the past 12 months is fully justified by the shift in Apple’s business model and product portfolio, I also see little opportunity for further P/E growth beyond the current 24x mark (see graph above).
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Disclosure: I am/we are long AAPL, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.