Earnings season is in full swing, and Wall Street’s top analysts are getting busy re-evaluating stocks ahead of the quarterly releases. Apple, Inc. (AAPL) is one of these, having just received an upgrade from Raymond James. This upgrade comes in the face of mixed expectations on earnings and the business outlook; and so now let’s take a closer analysis of the tug-of-war between the bears and bulls on AAPL.
The Earnings Situation
Apple-watchers know what to expect in the two key bottom-line numbers – revenues are expected to come in at $53.4 billion, about the same as last year’s Q3, while EPS is projected at $2.10, a 10% drop from a year ago. Apple’s Services segment showed 16% growth last quarter, and is expected to show further growth for fiscal Q3. Apple has been pushing hard to promote established offerings like App Store, iCloud, and Apple Music, while building expectations on new products like Apple Card, Apple TV+, and Apple Arcade.
The full-court press on Services is part of Apple’s strategy to offset slowing iPhone sales. The flagship mobile device has been buffeted by a series of demand hits in the past year or so, including: customer complaints about slow modems; the drawn-out legal battle of Qualcomm, Inc. (QCOM), over modem chips, that was only resolved this past spring; multiple issues in China, including increased competition from Chinese handset makers and the simmering US-Chinese trade tensions.
While iPhone made up 63% of Apple’s revenue in the last quarter, management knows that its iconic product is on a downswing and is taking action. In addition to pushing Services, the company is streamlining and promoting its iMac, iPad, and Wearables lines. As CEO Tim Cook said back in January, “If you sort of back up and look at Apple, in our last fiscal year, we had $100 billion of revenue that was not iPhone... And in this last quarter, if you take everything outside of iPhone, it grew at 19 percent.”
The main questions for Apple investors approaching the Q3 earnings are, will the boost to non-iPhone revenue streams increase quickly enough to effectively counter the slip in handset sales; and, can iPhone recover sufficiently to hold its market share niche in a maturing smartphone environment? The answers to those questions, especially the second, brings us to the analyst reviews and Apple’s recent upgrade.
First, the Bear Cases
In recent days, the analysts have been pulling both ways on AAPL. The bearish case is set forth by Nomura’s Jeffrey Kvaal and Goldman Sachs’ Rod Hall. Looking at the just-finished June quarter, Kvaal says to have “low expectations for the impending iPhone cycle and do not expect Apple's new services to add materially to earnings. However, the company's ecosystem and buyback program remain strong.”
Hall takes a similar view, saying that Services boosts in the spring were derived mainly from two successful game launches in China. He writes, “We believe that increased growth in App Store revenues in March/April/May was likely driven by the launches of Perfect World and Game for Peace (PUBG)… we calculate that the persistence of weaker June growth in the September FQ4 would drive another 1.1pp of downside to our Services growth estimate.”
While both of these analysts are bearish on AAPL, both have also raised their price targets on the stock. Kvaal sets his at $180, Hall at $187. Both are well below the current trading price.
Checking in with the Bulls
The bullish news this week for Apple is the ratings upgrade from Raymond James. Analyst Chris Caso took a forward-looking stance on the stock, basing his upgrade not on this year’s performance but on “the impact of a 5G iPhone product cycle in 2020.”
He sees Apple gaining materially from its recent settlement with Qualcomm. While the settlement included a lump-sum payment from Apple to the chipmaker, it also resolved the patent dispute and allowed Apple access to Qualcomm’s high-quality modem chips. During the course of the dispute, Apple had fallen back on Intel Corporation’s (INTC) chips, and customers had noticed – and complained about – the difference. It’s a hazard of building a niche on a devoted fan base.
Expanding on this in his note, Caso said: “Our call may well be early – we expect this year’s iPhone cycle to be the weakest in years, and today may not be the right time to buy ahead of that weakness… But since the near-term market moves are being driven by macro conditions as much as fundamentals, we’ve decided to upgrade now and let our clients decide the best time to execute on our idea.”
In line with this general optimism on Apple’s longer-term outlook, Caso upgraded his rating to ‘buy’ and set a $250 price target. His price target, significantly higher than other analysts’, suggests an upside potential of 23% for AAPL shares.
Caso is not alone in taking the bull stance on AAPL. Merrill Lynch’s Wamsi Mohan has long maintained a buy rating on the stock, and recently reiterated it, along with this $230 price target. He based his rating on third part sales data showing “F3Q19 App Store revenue is ~$3.9bn (+18% y/y). This represents a slight acceleration from F2Q growth of 17%.” Mohan’s price target is indicative of a 13% upside.
Five-star blogger D.M. Martins Research also sees long-term positive trends ahead for Apple. Laying out a detailed bull case, the blogger concludes: “I believe AAPL continues to be a solid investment. In fact, I have recently called it ‘my FAAMG stock for the rest of 2019.’ Justifying my optimism is the company's long-term prospects, which I believe to be promising yet discounted for short-term worries over trade policy and global economic deceleration.
“More specifically, I see in the more stable and predictable services revenue growth and the success of new device form factors, including the Watch and other wearable products…”
The Bottom Line
Apple has shown strong growth in the past year, with the 29% share price gains outpacing both the NASDAQ and S&P 500 indexes, but the company has faced dangerous headwinds, too. To a large extent, Apple management has been able to manage the expectations over the past six months, lower the bar, and then beat the lowered expectations, but that strategy may be running its course.
The result, as seen above, is mixed reviews. Respected analysts are lining up on both the bull and bear sides for this stock, and there are strong cases made in both directions. The analyst consensus, however, remains bullish on Apple. AAPL shares get a moderate buy rating, based on 20 buys, 14 holds, and 2 sells assigned in the past three months. Shares are trading for $202, so the $215 average price target implies a 6.36% upside potential.
Disclosure: This author is long on AAPL.