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iPhone is Stronger Than an Acre of Garlic

I’ve been anticipating a slowdown in consumer spending for several months. In preparation, I took a look back at the 2008 financial crisis and was reminded that all companies will be impacted in a recession. Apple’s most recent quarter and September guidance is testing this idea. Apple is, once again, defying gravity and powering through the early stages of the macro downturn. This is based on what I believe, was the most important comment from the call: Cook’s assessment that, in respect to the iPhone, “there was no obvious evidence of macroeconomic impact during the June quarter besides FX.” The segment grew 3% year over year, which is more impressive than it sounds given it was up against a monster 50% comp. The iPhone is stronger than an acre of garlic.

iPhone is now an essential

One way to sleep well at night is to invest in companies with products that are essential. That’s why companies like P&G and Clorox can grow revenue at 3% and trade at 25x earnings. The iPhone is regarded by some as a luxury product, beloved mostly by wealthy consumers. That view likely stems from the fact that an average iPhone costs 20% more than a comparable Android phone in the US and 40% more globally. Some believe the iPhone can better power through a recession because its buyers have more money to spend on luxury. I disagree. Instead, I believe the strength of the iPhone is because it has transitioned from being a luxury product to an essential one. The vast majority of iPhone buyers are feeling the pressure from inflation. They are making decisions to save money, trade down on upcoming purchases when necessary, or hold off entirely. And, when faced with these hard choices, they’re deciding to spend on the iPhone. That’s noteworthy.

September guidance suggests inline with the Street excluding FX

CFO Luca Maestri’s September outlook calls for revenue growth to accelerate in Q4 compared to Q3. That’s despite “approximately 600 basis points of negative year-over-year impact from foreign exchange.” Translating that comment is more of a science than an art. The company grew revenue at 2% in the June quarter so to meet the acceleration target, growth in September would be at least 3%. That factors in a 6% FX headwind. This implies that September growth would be at least 9%, excluding the impact of FX, essentially inline with the 8% that analysts were expecting going into Q3. I sense that most analysts were not factoring in such a strong FX headwind so revenue estimates for September will likely come down. That said, I believe most investors exclude the impact of FX and will view Maestri’s September comments as inline if not slightly better than the Street.

Apple also said that the negative revenue impact from supply chain constraints would be lower in Q4 than in Q3, which means the hit will be likely be less than $3B. A sign of hope that supply chain headwinds are beginning to ease.

As for earnings, September gross margin guidance of between 41.5% and 42.5% compares to the Street at 42.8%. While Apple typically exceeds gross margin guidance, the probability they ultimately meet the 42.8% estimate is a coin flip. Putting it together, I would expect consensus EPS to come down slightly for September. The bottom line on gross margin guidance; it’s still impressive and highlights Apple’s ability to maintain historically high gross margin in the face of a soaring cost environment.

One blemish in the quarter

Some investors may take issue with the fractional miss in Services revenue as well as the Mac shortfall. My take: Services were essentially inline with expectations and the Mac headwind will be temporary, given it was related to the one-month hiatus in Mac sales after the debut of the MacBook Air. Another area of softness was Wearables, Home and Accessories which missed expectations by 10% and reported an 8% year-over-year revenue decline. The segment accounts for just under 10% of revenue. Cook said the category was up against a “cocktail of headwinds” including FX, supply constraints and the loss of business in Russia. I believe there was a fourth contributor to the softness, Watch and AirPods are not essentials so consumers are holding off.

Beyond September, the product pipeline is stacked

The conversation on Apple will soon shift to the FY23, and investors will likely conclude that Apple is in front of what will be a favorable new product year. I expect 11 new products to ship in FY23. This is more than the typical 7-9 products in a year. More importantly—looking beyond FY23—there are other potential areas of growth on the horizon, including health, AR/VR headsets and potentially something in auto. Just the hope of these potential game-changers should be a positive for AAPL’s multiple in the years to come.


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