bombuscreative/iStock Unreleased via Getty Images
The market selloff offers a buying opportunity for long-term investors. As the adage goes, invest when there’s blood in the streets. The Fed’s actions might suppress demand in the short run in exchange for inflation, but the foundations of economic prosperity are still in force. Unemployment is low, and wages and GDP are growing. The other two primary challenges facing the economy are external, namely China’s Zero-Covid policy and Geopolitical events disrupting fuel prices.
The US government is implementing a massive fiscal program, and the private sector continues to invest in productivity tools and digital transformation. Market reactions mirror the speculative bets on the shape of the economy. Although Apple Inc. (NASDAQ:AAPL) is susceptible to general economic conditions, these temporary disruptions are outweighed by AAPL’s brand, cash flows, and financial position.
I expect a strong Q2 (three months ended March), mirroring the continuation of strong demand for the iPhone 13 seen in Q1. China, representing a fifth of revenue and a quarter of operating profit, entered into lockdown in March. Thus, any effect will be felt more in the June quarter. Still, no one knows how this will pan out. There are still two months remaining in the June Quarter, and there are reports that the CCP is easing lockdowns. Economic cycles are temporary and most likely will be outlived by the Apple brand, currently trading at a discount.
Share buybacks and growing dividends are fundamental to AAPL’s share performance. Since 2014, the iPhone maker funded a small portion of these two programs through debt, capitalizing on low-interest rates, and strong credit ratings. Below is a chart summarizing AAPL’s capital allocation policy since 2014.
As the markets assess the effect of rising interest rates, AAPL shareholders are enjoying the safety of a well-structured investment fund, placing the company in an excellent position to profit from rising interest rates, offsetting rising borrowing costs. In 2021, this investment fund generated $2.8 billion in interest and dividend income, offsetting the $2.6 billion interest expense arising from ~$110 billion term debt.
AAPL Marketable Securities Breakdown (SEC Filings )
The company’s debt mainly bears interest at fixed rates, protecting it from rising rates in the short term. AAPL’s borrowing cost will most likely increase as it refinances its loans, but as mentioned above, this is offset by higher interest income from its $210 billion investment fund.
Every company attracts a shareholder base matching its characteristics inherent from its stage in the business lifecycle. For example, Netflix (NFLX) attracts growth-oriented shareholders. Last week, NFLX shares dropped 40% after less than impressive subscriber data, a widely-followed figure representing a gauge of the streaming service’s market position in the face of competition. What if this happened to AAPL? What if the total number of iPhone users dropped? I don’t know the answer, but AAPL’s market reaction to recent events mirrors a different shareholder base than NFLX.
AAPL mirrored resilience during the value-to-growth rotation, and this says a lot about the character of its shareholder base. Remember, earnings expectations matter more than absolute figures. AAPL investors are accustomed to and expect revenue variation and cyclicality of new products. 2021 was a super cycle stemming from the introduction of the iPhone 12, the first 5G phone, prompting users to upgrade older devices and new users to switch brands. Below is a yearly chart demonstrating AAPL’s annual revenue variations and 2021 super cycle.
Wall Street earnings expectations seem moderate this year, with a decline in the June quarter offset by YoY earnings growth during the holiday season. iPhone 13 rollout has been successful, enough to lift revenue above FQ2 and FQ3 moderate expectations, currently standing at 0% and -4.5% YoY growth. FQ3 earnings decline most likely mirrors pessimism over China demand, which went into lockdown in March. There are multiple tailwinds to support the 10% and 4.4% YoY revenue expectations in the holiday season, namely the rollout of iPhone 14 and a possible reversal in iPad sales, combined with continued revenue growth from the service segment, which represents 20% of total revenue.
AAPL EPS Suprise % (Seeking Alpha)
Statistically, the odds are in AAPL’s favor. In the past four years, AAPL beat revenue expectations 15 out of 16 times and EPS estimates 100% of the time.
AAPL Revenue Suprise % (Seeking Alpha)
AAPL’s antitrust challenges are blown out of proportion. Most revenue comes from hardware sales, which are immune from these troubles. APPL antitrust headwinds target a small segment of its revenue stream, unlike Google (GOOG) and Meta (FB), whose legal challenges threaten their core operating business model relying on ad revenue. Service revenue, which includes App Store commissions, among other services such as iCloud, Apple TV subscriptions, constitutes a mere 20% of revenue
One this should be careful putting too much emphasis on news headlines regarding dwindling online ad revenue, which is also included in the services segment.
Rising inflation will create margin headwinds, but it is remarkable that Apple didn’t experience the disruption facing other companies and industries due to the chip shortage. Moreover, the periodic rollout of new products allows the company to increase prices without rocking the boat or attracting too much negative publicity.
Overall, I believe that AAPL offers a favorable risk/reward profile. The company’s well-earned brand name will allow it to overcome current economic challenges. The effect of rising borrowing costs on the company’s debt expense is offset by its massive investment fund, currently standing at 200 billion, almost twice the size of its term loan.
Inflation could put pressure on margins, offset by the growing service segment, which enjoys high margins. One can’t know for certain the effect of macroeconomic disruptions on sales. However, I believe that the Apple brand will outlive these challenges.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of AAPL either through stock ownership, options, or other derivatives. 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.