Apple Earnings: I Advise Caution

Summary:

• Apple’s fiscal Q3 earnings report will be released today.
• The company has high expectations to meet after wide beats from Meta and Alphabet.
• Unlike Meta and Alphabet, AAPL’s revenue primarily comes from hardware sales, which are declining industry-wide.
• Analysts are not expecting positive year-over-year growth for Apple, as hardware shipments have been down across the industry.
• In this article, I explain why I continue holding my Apple shares ahead of earnings but am not buying more.

Apple (NASDAQ:AAPL) reports its earnings on August 3. The company has some big expectations to meet this time around. Just last week, Meta (META) and Alphabet (GOOG) reported earnings and easily surpassed analyst estimates, delivering positive earnings growth. If Apple does not meet estimates as well, it may be perceived as underperforming its sector.

If you look at Apple’s business mix, you’ll notice that it isn’t all that similar to Meta and Alphabet. Both of those companies are primarily advertising platforms. Apple does have a bit of app store advertising revenue coming in, but it’s not even big enough to get a separate line item on the income statement. Instead, it’s bundled in with app store sales in ‘services.’

Most of Apple’s revenue comes from hardware sales, and there have been signs that these haven’t been doing too well at other companies.

In the first quarter, $73 billion of Apple’s $94 billion in total sales came from hardware. That’s 77.6%. Apple’s ad revenue is part of services revenue, which as a whole is only 22.4% of total revenue. So, Google and Meta’s beats do not tell us a lot about how Apple performed in the quarter about to be reported.

Indeed, analysts are not expecting Apple to report positive year over year growth like Meta and Google did. Instead, they are expecting earnings to decline. It’s possible that continuing buybacks could push EPS growth to 0% (as happened last quarter), but net income is very likely to fall.

The reason for this is quite simple:

Hardware shipments are down across the industry. Android phone sales fell 37% in Q2. Mac shipments fell 40.5% in Q1. Even game console sales declined! Now, Apple has a unique brand that sometimes lets it defy industry trends, but we wouldn’t expect it to defy this much bearishness in computer hardware. Q1 Mac sales were consistent with what was observed at other companies-in fact, Mac shipments fell more than PC shipments did! So, we’d expect Apple’s revenue to decline. Unless there’s a big surprise in services revenue, then it’s almost a foregone conclusion. Analysts expect a 1.6% dip in revenue, so even a 1% beat on the top line would be negative year-over-year growth.

Of course, the stock market is a forward looking discounting mechanism, so if Apple comes out with rosy guidance, negative revenue growth may be forgiven. Theoretically, any result ahead of expectations justifies a higher price, providing that the price before the results came out was the correct one. Nevertheless, I do not expect Apple to perform as well post-earnings as Google and Meta did, for reasons that I will outline in the ensuing paragraphs.

Hardware Sales Slump

As mentioned previously, computer/smartphone hardware sales are falling at many tech companies. Apple was affected by this trend in Q1, Google in Q1 and Q2. It’s quite likely that today, Apple will also report declining hardware sales.

There are some data points we can use to infer this:

• U.S. smartphone sales fell 24% in Q2.

• Qualcomm (QCOM) chip sales fell 25% in the same period.

• RAM prices have been trending downward since 2022.

• As mentioned previously, Mac sales fell 40.5% in Q1, and Android phone sales fell 37% in Q2.

Taken together, these data points seem to imply that Apple’s hardware sales (that is, a 77.6% chunk of total sales) will decline in Q2.

How much will they decline?

That’s a good question.

I was able to find data on Apple’s Mac sales and other companies’ smartphone sales, but there’s very little publicly available information about categories like tablets and smart watches. It is known that Amazon (AMZN) ran an Apple watch sale for prime day, and absorbed the cost of the discount on its end. So, it’s possible that Apple watch sales will be higher than expected. However, the Apple watch is a pretty small part of Apple’s business mix. On the whole, there is little reason to think that Apple’s hardware sales won’t decline in Q2. For this reason, I concur with the analyst consensus of $81.8 billion dollars in Q2 sales for Apple, which would be a 1.4% year-over-year decline.

The Cost Side

Having looked at where Apple’s revenue is likely to come in today, we can now turn to the cost side of the equation.

Unlike Google and Meta, Apple has not announced any big layoffs this year. In May, CEO Tim Cook called layoffs a last resort, pledging only to freeze hiring. Later, when Apple released its second quarter earnings, it revealed a $2 billion decline in cost of sales (“COGS”), and a $1 billion increase in operating expenses. Total costs fell by $1 billion. Given that revenue is expected to decline 1.4%, that COGS correlates with revenue, and that Apple has pledged to freeze hiring, we would expect Apple’s costs to be roughly the same as in the second quarter.

From this, we can arrive at a net income estimate:

• $81.8 billion in revenue.

• Subtract $41.9 billion in COGS and $13.65 billion in operating expenses, to give $26.25 billion in EBIT.

• Leave out net interest expense as it’s been negligible for Apple in recent quarters.

• Assume a 15% tax rate (based on the second quarter), to yield $22.31 billion in net income.

So, if Apple’s revenue meets the analyst consensus and costs remain unchanged like I expect them to, we should get $22.31 billion in net income.

Earnings Per Share

The final figure we need to estimate is earnings per share (“EPS”). This is tricky because it depends on the size of the buyback Apple did in Q2, which is not known. We do know that the company had 15.85 billion diluted shares last quarter. EPS at that share count would be $1.407. If on the other hand Apple bought back 556 million shares, like it did in the second quarter, then EPS would be $1.45. Analysts are only expecting $1.19 in EPS, so both figures would represent significant earnings beats. Also, this time around, the year-over-year earnings growth would be positive under my assumptions, whereas in Q2, the buyback only pushed it to 0%. So I think there’s a good chance that Apple beats on the bottom line, and I also think there’s a chance of positive year-over-year earnings growth. It should be stressed, though, that my EPS forecast is much, much more optimistic than the analyst consensus.

Valuation

Having looked at Apple’s upcoming earnings, it’s time to see how they will affect the stock’s valuation (assuming my forecast turns out to be right).

For the trailing 12 month period, and using today’s stock price, Apple trades at:

• 33.2 times earnings.

• 8.11 times sales.

• 49.5 times book value.

• 23.24 times operating cash flow.

Now, how will today’s results impact this valuation?

Put simply, if the stock price does not change, then the multiples will be similar to what they were before.

If, as I suspect, Apple retired somewhere around 556 million shares last quarter, we’ll get:

• 15.294 diluted shares,

• $1.45 in EPS-$6.14 for the trailing 12 month (TTM) period.

• $5.34 in revenue per share-$24.32 for the TTM period.

• $4.05 in book value per share (this assumes $1.21 worth of EPS goes to retained earnings, while $0.24 is paid as a dividend).

Using Wednesday’s closing price ($192.58), these figures would give us:

• A 31.5 P/E ratio.

• A 7.91 price/sales ratio.

• A 47.44 price/book ratio.

As you can see, the multiples are all in the same ballpark as Seeking Alpha’s current multiples, although they decline slightly due to the impact of the modelled buyback. So, we’d expect Apple to remain a little on the pricey side after today’s earnings come out.

The Bottom Line

The bottom line on Apple’s upcoming earnings release is that it’s unlikely to be as good as the ones Meta and Google recently put out. As a hardware company, Apple is up against too many headwinds to put out really exciting numbers. Potentially, a big beat in services could drive better earnings figures than what I’ve estimated-although I’m already estimating an EPS figure well above the analyst consensus. It is possible that Apple’s Q3 revenue and earnings growth will be negative, but I wouldn’t rule out the possibility of a post-earnings rally on rosy guidance. Personally, I continue holding my shares, although I’m not buying more at these levels.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AAPL, GOOG 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.

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