Thesis Strengthens on Apple [AAPL]

Apple posted strong fiscal Q3 results Tuesday, demonstrating the continued pricing power of the iPhone and the stickiness of the company's software & services ecosystem. At the after-hours price on Tuesday, it reached $995 billion in market cap and could shortly become the world's first $1 trillion public company.
The company grew its quarterly revenue and EPS by +17% and +40% year-over-year, in line with Wall Street estimates. Next quarter's guidance was also above estimates.
More important for Apple's future business and financial prospects is the complexion of that performance. Let's dive into how this quarter and management's guidance reflect Apple's two most fundamental moats: brand equity and network effects.
First, on the hardware front:
Many were hanging high hopes on Apple's flagship handset (the iPhone, which is 60% of Apple's revenue) and its climbing ASP. This quarter, the company delivered. The 41.3 million iPhones shipped during Q3 is basically flat from last year, but the average selling price of $724 is a notable jump. This bump is likely due to an increasing mix of the pricier iPhone X, which starts at $999.
Our main takeaway from this robust pricing growth is that Apple continues to improve its brand equity and expand its pricing power.
In a world of ever-increasing selection of lower-priced Android phones and already-high Apple penetration, Apple is undoubtedly seeing its iPhone unit sales growth slow. But the company is building digital services and a suite of other gadgets around the device. Those newer businesses, along with higher price iPhones, are widening Apple's brand equity and supporting continued pricing power and revenue growth. And pricing power, as Buffett often puts it, is the "holy grail" in investing.
Next, on the software front:
Investors have been watching closely as Apple ups its software and services revenue -- a catch-all category that includes the App Store, Apple Care, Apple Pay, iTunes, and iCloud services. This segment has been outpacing iPhone revenue growth for several quarters.
Apple positively surprised with $9.55 billion in software and services revenue this quarter (+31% growth). We think there's still tremendous opportunity left for growth in this sticky, high-margin app/developer ecosystem. The reason (and the moat): network effects.
As Apple acquires more iPhone users from a hardware perspective, it grows the distribution channel through which app developers sell/offer their apps. This is great for developers because it widens their consumer audiences, and it's great for consumers because it widens the selection of apps, software and other services to make the smartphone experience more rich and engaging. As each side of the network grows in size, so does the value that each side of the network gets out of it.
CEO Tim Cook said in January 2017 that the company hoped to double services revenue to more than $14 billion per quarter by 2020. That's almost 50% higher than Apple's current sales for that segment. Oh and it's a much higher margin business than iPhones too (because it costs almost nothing to plug a new developer into the App Store ecosystem, vs. the hardware that goes into an iPhone).
Finally, on the forward-looking guidance:
Apple expects Q3 revenue to come between $60-62 billion (+23% growth), edging out Wall Street predictions of $59.5 billion.
Recall that the company's recent quarterly results have been weighed down by concerns that it has saturated the smartphone market, marking the end of the iPhone "supercycle." The next quarter (fiscal Q4) is when Apple typically introduces new iPhone models -- usually in mid-September. Therefore, Q4 guidance is arguably the most important operating forecast that management provides to investors to gauge how the business and its product cycles will fare.
The company's strong guidance today suggests that multiple new hardware devices are coming in the fall (up to three new iPhone models). Per Tim Cook, "we are very excited about the products and services in our pipeline."
Overall, our thesis has become even stronger on Apple. Similar to Warren Buffett's investment case, we believe Apple is truly a consumer brand at heart (vs. a classic technology or hardware company). Steady-growing consumer brands not only warrant higher prices and profits over time, but they tend to command higher public market valuations (given the predictability and secular growth of their earnings) than the hardware companies (which tend to be more cyclical, harder to predict and more susceptible to commoditization/price erosion from competition).
At only 14x P/E on Wall Street's 2019 earnings estimates, AAPL still appears too cheap for a growing consumer brand with pricing power and network effects.
Jul. 31st, 2018
Share
As of this writing, AAPL was a portfolio holding of Titan Invest. This security may cease to be a portfolio holding at some point in the future.
The statements, opinions and analyses presented herein generally are provided as general information. Opinions, estimates and probabilities expressed in Titan research constitute the judgment of the author as of the date indicated and are subject to change without notice. While all the information prepared in the foregoing articles is believed to be accurate, Titan Invest (“Titan”) makes no express guarantee as to the completeness or accuracy of, nor can it accept any responsibility for errors appearing in, the foregoing articles. Other events which were not taken into account may occur, and any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The information contained herein is not, and should not be construed as, an offer to sell or the solicitation of an offer to buy any securities. In addition, nothing contained herein is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. While Titan is a federally registered investment adviser, the information presented is not part of the personalized, proprietary algorithmic based investment advice provided by Titan to its advisory clients. Rather, the information presented constitutes educational and informational materials meant to better inform market participants, including, without limitation, current and potential advisory clients of Titan. Prior to making any investment decision, you are advised to consult with your broker, investment adviser, or other appropriate tax or financial professional to determine the suitability of any investment. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy discussed herein will be profitable or equal any historical performance level(s). Neither Titan, any of its affiliates, nor each of their respective officers, directors, members, agents, representatives, employees, or contractors (collectively, “Titan Parties”), shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided herein. You assume all risks of loss resulting, directly or indirectly, from the use of the information contained in the foregoing articles. By accepting receipt of the foregoing articles you acknowledge and agree to hold harmless the Titan Parties from any and all claims, actions, damages, losses, liabilities, costs and expenses of any kind whatsoever, including but not limited to any claims of negligence, arising out of, resulting from, by reason of, or in connection with the use of the information contained in the foregoing articles. Securities laws impose liabilities under certain circumstances on persons who act in good faith, and therefore no portion of the above shall constitute a waiver or limitation of any rights you may have under any federal or state securities laws.
Certain articles discuss historical performance of a particular issuer over a limited period of time. The historical performance discussed in such articles represents gross performance of the issuer over the limited period of time depicted, and is not indicative of any actual portfolio or investment returns of any account. Any such returns, even if an account was invested in the security discussed over the limited period of time depicted, would be reduced by fees and expenses paid by any such account. The foregoing articles contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results. Comparable companies, strategies, portfolios and indices may be included in the foregoing articles only as a context reflecting general market results during the depicted period or as of the specified date. The comparison of any company, strategy, portfolio or index to a single other company, strategy, portfolio or index may be inappropriate because the relevant assets, strategies and level of risk may vary materially from the comparable company, strategy, portfolio or index as a whole. Titan uses a proprietary algorithmic strategy in selecting recommendations to advisory clients. Issuers and/or securities discussed herein may be, and often are, held by clients of Titan in their investment portfolios. Any single security or issuer identified in herein will not represent all of the securities purchased, sold or recommended for advisory clients of Titan. Please see Titan’s website and Program Brochure for more details on security selection for advisory clients. Before investing, consider your investment objectives as certain investments are not suitable for all investors. Past performance is no guarantee of future results.
© Copyright 2018 Whisker Technologies, Inc. All rights reserved.