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Apple’s Growth Story Will Continue

Apple reported March quarter results with revenue 16% above the Street. While growth rates will fluctuate, Apple will remain a growth story for the foreseeable future. The company will benefit from a multiyear 5G cycle, an accelerating digital transformation driving demand for its products and services, and eventual new product categories. Putting it together, we believe shares of AAPL will approach $200 (48% upside from current levels) over the next several years, based on 35x our 2022 EPS estimate of $5.70. As analysts update their estimates, we believe consensus expectations for 2022 EPS will be closer to $5.00.

Is this as good as it gets?

We’re hard pressed to remember a quarter with this kind of beat. It’s reminiscent of the upside in some quarters a decade ago, when iPhone was ramping into new carriers. Investor enthusiasm related to the March quarter is diluted by concerns about sustainability of these spectacular results.

For those who have closely followed the Apple story, the “it can’t get better than this” line of thinking is a well-traveled investment outlook. Despite these perennial concerns, Apple has launched new products and services to keep the impressive results coming. We believe this pattern will continue in the decade ahead, as the company adds hardware as a service offerings, launches mixed reality products, and finds a path into the massive addressable market of the upcoming transportation paradigm shift to autonomy.

We believe that Apple’s best days are still ahead based on an accelerating digital transformation that we cannot yet fully comprehend.

Key March results:

  • Guidance: Apple doesn’t give formal guidance; rather, the company offers high-level direction on its earnings call. Apple expects a more dramatic sequential percentage decline from March to June than in prior years. The March quarter benefitted from the timing of the latest iPhone release, easy comps, and stimulus spending. Additionally, component shortages will have a $3-4B negative impact on the Mac and iPad business in the June quarter. We believe overall revenue will decline in the June quarter by about 20% sequentially. For perspective, over the past five years (excluding 2020 because of the pandemic dynamics), June quarter revenue has been down on average 14% from March. Additionally, the company said to continue to expect gross margins in June similar to the 42.5% they reported in March. This is particularly impressive given Apple’s gross margins have hovered in the 38%-40% range over the past decade. The last time the company reported a 42.5% gross margin was in June 2012.
  • Cash: Apple ended the March quarter with $205B in total cash and $122B in debt, or $83B in net cash. We had expected total cash at the end of March to be $190B, with $112B in debt, or $78B in net cash. The topic of Apple’s cash position is more complex than its cash balance. Apple has outlined a goal to be net cash neutral over time, suggesting that total cash will eventually equal debt. This is good news for investors—they can expect an additional $83B in cash will be returned through buybacks and dividends or otherwise strategically deployed. Some of that cash has already been committed to investors through the company’s capital return program. The challenge is that the company is generating so much net income that the road to net cash neutral is long and slow. They can’t get rid of it fast enough. In the end, Apple has a good problem when it comes to cash—a gravy train of cash returning to investors, which is not fully appreciated.
  • Update to capital return program: Apple increased its share buyback by $90B versus $50B a year ago and raised the dividend by 7% versus 6% a year ago, along with committing to annual dividend increases. The bottom line is the business continues to be profitable at a level that is making it difficult for the company to reach net cash neutral.
  • Revenue: March quarter revenue was $89.6B (up 54% y/y) compared to the Street at $76.8B (up 32% y/y), driven by upside in every product category.
  • Earnings: EPS was $1.40 (up 119% y/y) compared to the Street at $0.99 (up 53% y/y), driven by a favorable mix of products as well as a favorable mix of Services revenue.
  • iPhone: March iPhone results benefitted from the timing of the latest iPhone release. iPhone revenue was 54% of sales (typically around 50% of sales), up 66% y/y to $47.9B, above the Street’s $40.8B estimate (up 41% y/y). We believe that nearly $2B in iPhone revenue was pushed from the December quarter, given the delayed timing of the fall iPhone release. While the timing of the latest iPhone release benefitted the March quarter, normalizing for this change, the segment’s underlying demand remains better than expected. We continue to believe the 5G upgrade cycle will be multiyear, as carrier 5G speeds improve over the next few years.
  • Services: Services revenue was 19% of sales, up 27% y/y to $16.9B (Street $15.5B) accelerating sequentially from 24% y/y growth in the December quarter. For context, the segment has averaged 19% growth over the past two years. This shouldn’t be a surprise, given App Store revenue has seen a combination boost from increasing game revenue and the accelerating digital transformation tailwind.
  • Mac: Mac revenue was 10% of sales, up 70% y/y to $9.1B (Street $6.9B). Given the Mac component constraints, along with difficult year-0ver-year comps, we expect Mac revenue to decline 17% y/y in June. As supply improves, we expect the Mac growth rate to rebound near 10% quarterly over the next two years.
  • iPad: iPad revenue represented 9% of sales, up 79% y/y to $7.8B (Street $5.8B). iPad is also benefitting from the work from home and distance learning trends. Given similar component constraints are affecting iPad, we expect iPad revenue to decline 20% y/y in June.
  • Wearables: Wearables, home, and accessories revenue came in at $7.8B (Street at $7.5B). We remain optimistic that the Wearables segment (about 10% of revenue) is in its infancy. AirTag will give this segment a small but measurable boost in the years to come. The company commented that Apple Watch continues to do well, with three out of four buyers new to the product. Notably absent from Cook’s comments were AirPods, which we believe are seeing a step-down in growth to 20% in March versus 35% last December. Going forward we believe difficult comps will mute AirPods growth. We are expecting a mid-teens increase in AirPods revenue in 2021, down from mid-50s in 2020.

Looking forward

We believe the March quarter results were a step toward our prediction that Apple will be the top-performing FAANG stock this year, based on three factors:

  • The accelerating digital transformation means more people are working and learning from home, providing a continued tailwind for the iPad and Mac businesses (about 25% of total revenue). We believe these two segments can grow at 10% plus in 2021 and 2022, compared to flat growth over the last few years. If correct, that would be in line with consensus estimates for this year, and about 10% ahead of the Street for next year.
  • 5G enthusiasm will grow in the back half of the year, starting a two to three-year iPhone upgrade cycle.
  • Growing anticipation of new business segments that could be announced this year and likely won’t launch until 2022 at the earliest. We expect this summer the company will preview its mixed reality goggles. Notably absent from the earnings call was any questions related to augmented reality. Over the next couple of years, we expect the company will offer hardware subscription offerings that build toward a 360° bundle, along with eventually addressing the massive opportunity around autonomy with Apple Car.

China growth accelerates

In March, China revenue was up 87% y/y, an acceleration from December’s 57% growth. China was more shut down than the rest of the world in March 2020, making for an easier comp in the March 2021 quarter. China now represents 20% of overall revenue compared to 19% in the December quarter. We believe success in China was predominately driven by iPhone 5G, given carrier coverage is more built out in China compared to the rest of the world. We believe the region will enjoy another one or two quarters of outsized growth and then return to growth more in line with Apple’s overall business.

The Epic trial

On the earnings call, the company responded to a question related to the upcoming trial versus Epic, noting the App Store fee structure is not cast in concrete. This comment was related to Apple lowering its commission rate to 15% for small developers in 2020, in an effort to “move with the times.” While this language suggests Apple may be open to future changes to App Store commission rates, we do not expect the company to willingly yield any ground in the Epic commission dispute.

As a reminder, May 3rd marks the start of the Apple v. Epic bench trial, with a decision likely coming in early June. At stake is the App Store take rate, which is consistent with the broader industry’s two-sided marketplace take rates. Given iOS represents a large share of the global app store market, Epic argues that the 30% rate is egregious. For a deeper dive on the trial, check out Loup’s perspective.


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