We’ve watched Apple report more than 70 quarters, and it hasn’t gotten old yet. The quarterly tradition is an opportunity for investors to check in on Apple’s progress toward maximizing what we call digital leverage: the simultaneous increase in value for both customers and shareholders.
Apple has written the playbook on digital leverage. The June quarter results are further evidence of the company’s proven process and its outcomes. Apple continually improves its hardware + software + services ecosystem to deliver more value to customers (driving revenue growth) and more value for shareholders (via improving profitability).
Let’s dive in. Apple reported June quarter revenue of $81.4B, up 36% y/y, well exceeding Street expectations of 23% revenue growth. EPS was $1.30 (up 100% y/y) compared to Street consensus of $1.01 (up 55% y/y). That’s digital leverage.
There were some doubts heading into the print about the sustainability of growth. It’s clear that growth will slow next year, as it will for almost all big tech. For Apple, revenue growth will likely end up mid to high single digits compared to the Street that’s looking for low single-digit growth. We believe that 7-9% top-line growth is sustainable for a few years until Apple launches into new product categories like AR, wearables, wellness, and automation (maybe vehicles). At that point growth will step up again, putting investors’ growth sustainability questions to rest, at least for a few more years.
Key June Quarter Results:
- Guidance: Apple doesn’t give formal guidance but instead offers high-level direction on its earnings call. On the call, the company said to expect growth rates to decline sequentially and still be firmly in the double digits. Translation: we believe September growth will come in around 25%, down from 36% in the just reported June quarter. That implies $81B in revenue, inline with the Street. Additionally, the number would have been higher if not for component shortages for the new iPhone and iPad that will likely have more than a $3B impact in September. In other words, if not for component shortages, guidance would have been closer to $84B. Notably, this is the first time the company has talked about iPhone being supply constrained. In the end, investors should be indifferent if the sales fall in the September or December quarter. Either way, iPhone users are upgrading to iPhones. Separately, gross margin guidance of 41.5%-42% is favorable, given it’s above the 38-40% range the company has reported over the past eight years.
- Cash: Apple ended the June quarter with $194B in total cash and $122B in debt, which is $72B in net cash. We had expected net cash to end June at $75B. Apple has previously stated their goal of being net cash neutral over time, with total cash equaling total debt. That goal still appears to be in place, given their decreased net balance, down from $83B total in March.
- Revenue: June quarter revenue was $81.4B (up 36% y/y) compared to the Street at $73.3B (up 23% y/y).
- Earnings: EPS was $1.30 (up 100% y/y) compared to the Street at $1.01 (up 55% y/y), driven by a favorable mix of products as well as a favorable mix of Services revenue.
- iPhone: Unlike March, July did not see the benefit of any new hardware releases. Because of this, iPhone revenue fell to $39.6B down from $47.9B last quarter, this is above the Street’s $34.0B estimate and still up y/y. This made up 49% of the company’s total sales for the quarter. Even though Apple lacked a big new iPhone launch this quarter, the emergence of 5G, which is the most significant technological upgrade to an iPhone in years, will likely drive more sustained sales in the future. We continue to believe the 5G upgrade cycle will be multiyear, as carrier 5G speeds improve over the next few years. On the call Tim Cook agreed with this outlook, suggesting we are early in the 5G transition, with only a few countries reporting 5G adoption of greater than 10%. The pace of 5G upgrades is in part in the carriers’ hands, given the need to increase network speeds to encourage upgrades. Our test of the three US carriers found 5G download speeds still well below 100MB, 10% faster than our end of 2020 poll, and well below the 5G goal of 1GB download speeds.
- Services: Services revenue was up 33% y/y to $17.5B (Street $16.3B), 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 doubled boost from increasing game revenue and the accelerating digital transformation tailwind.
- Mac: Mac revenue was 10% of sales, up 16% y/y to $8.2B (Street $8.0B). Given the Mac component constraints and difficult year-over-year comps, we expect low to mid-single-digit growth next quarter.
- iPad: iPad revenue represented 9% of sales, up 12% y/y to $7.4B (Street $7.3B). 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 be flat in September.
- Wearables: Wearables, Home, and Accessories revenue was reported as $8.8B (Street at $7.8B). This is a 35% increase y/y.
- Profitability: Apple’s gross margin was 43.3% compared to expectations of 41.7% and up from 38.0% in the year-ago quarter.
We believe that, despite the relatively slow stock growth in the first half of the year, Apple will be the top-performing FAANG stock in the second half, based on three factors:
- The growth of 5G should entice more users to upgrade to new iPhones in the coming months. As 5G coverage improves, more and more will upgrade and switch to iPhone.
- The digital transformation will continue to benefit the Mac and iPad business from work and learn from anywhere.
- Increasing optimism about what Apple can do in new product categories including AR, auto, and wellness.
The big picture is the shift to EVs, autonomy, and renewable energy will take longer than most think but will be more transformative in the end than most appreciate. We maintain the view that this reality will likely create near-term volatility in Tesla shares. In the end, we continue to believe these segments will be the foundation of the future of transportation and energy consumption and will increase Tesla’s market cap over the long run.
Margin improvement builds the case for a tech multiple
The biggest takeaway from the June results was that automotive gross margins ex-credits were a record 25.8% despite overall ASPs down 2% y/y (due to a higher mix of cars sold in China) and a higher-priced component environment. The Street was looking for 22.5% compared to 22% reported in March of this year. Deferred revenue increased quarter on quarter by 6%. This suggests the strong auto margins saw limited benefit from Tesla recognizing high margin FSD dollars off the balance sheet. Improving auto margin is important because for Tesla to maintain its tech-like multiple, the company will have to expand auto margins into the 30% range.
Delivery guidance. The company reiterated its 50% average annual delivery growth rate over a “multi-year horizon” and expects deliveries to grow greater than 50% in 2021. The Street is around 65%, and we estimate 2021 delivery growth will be closer to 80%, driven by the Model Y ramp in Shanghai, the beginning of vehicle deliveries from Giga Berlin and Austin, and favorable 2020 comps. Tesla is experiencing accelerating delivery growth, the defining feature of a growth story:
- Cash on hand stands at $16.2B, down from $19.1B in March and $19.4B in December, largely due to net debt and finance lease repayments of $1.6B, offset by free cash flow of $619m. In the quarterly letter, the company stated they “have sufficient liquidity to fund our product roadmap, long-term capacity expansion plans, and other expenses.”
- Full autonomy. For the second quarter in a row, there was a pause in the company’s public commentary around the timing of full autonomy. Musk did say he has no doubt autonomy will be reached, given automation is safer than a human driver. Our guess is we are three to five years away from full autonomy.
- FSD subscription. Musk expects the FSD subscription, which launched last week, to slowly build and be “a significant factor next year.” Translation: it will have a significant impact in 2024. The year matters less than the fact that consumers will likely buy the high-margin FSD offering at an increasing rate as more features are added. We believe, longer-term, FSD subscriptions will have a powerful impact on Tesla’s earnings.
- Tesla Semi deliveries will be delayed from previous expectations of late in 2021, now expected to begin in 2022. While annual semi deliveries will be minuscule, it is an important platform given long, predictable highway miles are ideal conditions for full autonomy. We believe Tesla’s long-term vision for its trucking segment is to sell semis and eventually offer a high-margin logistics and dispatch layer that would compete with traditional logistics companies like C.H. Robinson. The biggest recurring constraint on Semi production will be battery cell capacity. Semis require 5x more cells than a car, and the company is already cell constrained.
Apple will report June quarter results on Tuesday, July 27th. We expect fractional upside to June consensus revenue growth estimates of 23% y/y and EPS of $1.01. The numbers will continue to have noise given that comps are the most difficult they’ve been since Sep-18, along with component shortages that likely had a $3-4B negative impact on the Mac and iPad sales. If not for the component shortages, revenue growth would likely be closer to 30% y/y. We expect the results will continue to instill confidence that the company will grow revenue around 30% in FY21, compared to 6% in FY20. The accelerating digital transformation will continue to be a tailwind for Apple’s revenue growth for the next several years.
The growth story will continue
Following March’s impressive 54% revenue growth that resulted in 16% upside to Street estimates, many investors felt the March quarter was as good as it gets for Apple. While growth rates will fluctuate, Apple will remain a growth story for the foreseeable future. Over the next two plus years, the company will benefit from the following tailwinds:
- 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 20+% in 2021 and closer to 10% in 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 7% 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 likely won’t launch until 2022 at the earliest. The three biggest untapped markets include AR/MR, wellness, and the opportunity around autonomy with Apple Car. Despite the continued rise in AAPL share price, we believe new product categories are nominally reflected in the current valuation.
How to think about the stock: The case for $200
Putting it together, we believe shares of AAPL will approach $200 (35% upside from current levels) over the next couple of years, based on 35x our 2022 EPS estimate of $5.70.
Key June metrics
- 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. We expect net cash to decline in June to $75B. 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.
- Revenue: We expect fractional upside to consensus revenue estimates of $73.3B (up 23% y/y). Some analysts’ expectations have drifted above $76B. We see reported revenue in the range of $74B or $76B as confirmation that the growth story is continuing.
- Earnings: We expect EPS of $1.04 (up 61% y/y), ahead of the Street at $1.01.
- Guidance: When the company reported March 2020 quarter results, they stopped providing guidance. That said, they have been increasingly been giving commentary on the earnings call that resembles guidance. We expect uptake commentary given pent-up demand for Mac and iPad in the June quarter should spill over to revenue in the September quarter.
- iPhone: (48% of sales) June iPhone results will see continued benefit from early 5G adoption, an aging base of iPhones 3 years old or older, along with the positive impact from residual stimulus checks in the U.S. Putting those together, we expect 33% y/y growth to $35.2B, ahead of the Street at $34.2B.
- Services: We expect Services (22% of sales) to be up 18% y/y to $15.9B, compared to 27% y/y growth in the March quarter. Analyst expectations are calling for 24% growth. The Services segment does not benefit from an easy year-over-year comparison given demand for Services was steady during 2020. Looking forward, we expect Services growth will dip in the upcoming September quarter given the difficult comps. Long-term, we expect growth to remain around 15% consistently as Apple continues to layer on more Services, including recently announced Apple Fitness+ and its podcast marketplace.
- Wearables: Apple does not report this metric but Loup tracks estimates. We expect wearables (9% of sales) to be up 23% y/y, compared to up 32% last quarter. We believe this segment has lagged, given Apple Watch is viewed by consumers as non-essential compared to iPhone, Mac, and iPad. Adding to the Watch sales headwind has been limited capacity at Apple Stores, where many first-time Watch buyers shop. Apple TV, Home, and Accessories add an additional 2% to overall revenue with mid-single-digit revenue growth.
- Mac: We are modeling for Mac revenue (11% of sales) to be up 13% y/y to $8B. The Street is expecting 10% growth. This segment is a wild card given component shortages. We know that inventory remains tight, and we measured lead times for Mac at the end of June at around 7 days, above its normal June quarter same business day.
- iPad: We expect iPad revenue (10% of sales) to be up 9% y/y to $7.2B. We believe the Street is expecting 8% growth. This is a step down in growth from 79% in March given the impact of component shortages that the Apple called out when they reported the March quarter. Similar to the Mac, we observed iPad lead times at the end of June extending longer than typically at about 14 days, a sign that some of June iPad demand will find its way into the September quarter.
Thoughts on the Epic trial
No word yet from Apple v. Epic bench trial which ended in May. We had expected a decision in June, and believe it could come any week. 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 app store dollar values, Epic argues that the 30% rate is egregious. At Loup, we are split on how the decision will play out, with two of the partners expecting a win for Apple and one expecting it to be in favor of Epic.
The chip shortage
Most tech hardware companies are reporting difficulties in procuring components in the June quarter given global chip shortages. While we had expected these issues to be worked out by the end of the June quarter, we now believe it could be many months before resolution. Recently, Intel CEO Pat Gelsinger reiterated his expectations the global chip shortage will worsen in the near term, and be present going into 2023. The good news for Apple is that component shortages mean products don’t reach supply demand equilibrium, which should give investors confidence that Apple can’t keep up with demand. This is generally favorable for shares of AAPL.
Questions for the call
Here are our top six questions we want to ask Apple on the earnings call:
- In investors’ eyes, you’ve been a victim of your own success and there’s a perception the results can’t get better from here. What’s the case that the more conservative investors are wrong?
- When you think about going into a new market, you’ve said it needs to line up with bringing hardware, software, and services together. Beyond the Apple Watch, is there an opportunity for wellness to expand around this hardware-software-services paradigm?
- Is it true Kevin Lynch has a new job at Apple?
- What’s your latest thinking on AR?
- The pace of opening new Apple Stores has slowed. How do you balance servicing a growing user base without expanding your brick and mortar footprint?
- If Epic wins its lawsuit, what does it mean for Apple?