Stocks markets hang on Apple earnings

Stocks markets hang on Apple earnings

Summary

Apple’s third quarter results could stabilise U.S. stock markets, or, if they disappoint, sentiment could worsen.

High stakes

Consumer-facing technology shares have largely underperformed the wider market this month as investors set a high bar for profits and some sector leaders come up short. With the Nasdaq stock market also lagging, investors could even be questioning a years-long bias for fast-growing high-beta shares over their slower moving ‘value’ counterparts. Since that investment style has driven stock market gains over the last couple of years, a lasting switch could have bigger implications. Apple’s third quarter earnings after the U.S. market’s close, could go a long way towards rekindling appetite for tech stocks and high-beta investing in general. Shares of the $933bn group are up more than 10% this year, so stakes are also high for iPhone maker itself.

Profit jump expected, phone sales to flag

Wall Street’s headline expectations are that Apple will report Q3 earnings per share of $2.18, according to a consensus compiled by Thomson Reuters. If seen, that would equate to a rise of about 30% compared to a year ago. Net income is forecast at $10.935bn, some 25.4% higher year-on-year, a much faster pace than Apple’s 11.8% net income rise in 2017’s Q3. Revenue is expected to be $52.6bn, about 15.9% higher. Almost as importantly, investors will look for guidance on Apple’s current quarter too, Q4. Wall Street currently expects revenues in the three months to end-September rising 12.8% to $59.3bn, with EPS seen 28.8% higher at $2.67. Q3 is typically a slow quarter for the product that remains Apple’s biggest revenue generator, the iPhone. Furthermore, the group is in between major handset iterations and new iPhone models are unlikely to be released until the winter quarter. For these reasons, handset sales are forecast to be ‘just’ 26.36 million in Q3, compared to almost 40 million retailed in Q2, and 41.03 million in third quarter of 2017.

Margin steady

In recent years investors have also increasingly scrutinised Apple’s gross margin on account of the group's capital-intensive efforts to stay at tech’s leading edge, which requires significant investments. Apple said in February it expected the basic measure of profits the group converts from sales to be between 38% and 38.5%, around the margin’s long-term average. Investors’ strongly negative reactions in recent days to U.S. multinationals that have reported rising marginal costs that may pose a risk to profits suggest Apple shares may not be spared if its gross margin disappoints.

China in focus

China has been another particularly sensitive theme for Apple over the years, not least as the Greater China region remains the group’s fastest growing revenue generator. As China has been at the centre of the United States’ increasingly fraught trade relations, investor attention on Apple’s statements concerning the country will be even more rapt. Apple has volunteered no specifics about how the trade conflict could impact sales or manufacturing in China, but with most iPhones made there, the implications are obvious. Handsets and other Apple hardware would be subject to higher import duties, just like any other imports into the U.S., should Washington go ahead with $500bn in tariffs on Chinese made goods. With Beijing’s retaliatory threats almost at the threshold of total U.S. exports, amounting to about $130bn, there is speculation China could begin to target specific companies. Analysts are likely to press Apple for its assessment of the risks. On the positive side, whilst Apple’s sales growth in China tailed off in 2016 it began rising again late last year and a 21% advance in the second quarter of the current year was its best in 10 quarters. With no tailwind this time from a surge in demand for the iPhone X—the best-selling smartphone in China in the first three months of the year—Apples revenue growth in the June quarter may be less spectacular.

Service revenues may surprise

Other points to watch include progress of Apple’s $100bn share buyback announced in May. Bearing in mind Apple also said at the time it would repatriate $250bn in cash from overseas to take advantage of new, more favourable tax laws, the group faces a higher hurdle to reach its targeted ‘cash neutral’ status. On that basis, there is a chance Apple may raise the amount of cash it plans to disburse, though timing of any increase is difficult to predict. Apple has also been progressing rapidly in its plan to reduce dependence on hardware in favour of higher revenues from music, software and other intangible goods. CEO Tim Cook said the group would double such sales to about $50bn by 2020. So-called service revenues are forecast to have risen 25% to $9.2bn in Q3. The group has proven just as adept at rapidly expanding service sales as it was when handset sales were peaking. That makes service revenues the likeliest to show an upside surprise. If seen, Apple shares could be underpinned.