Apple Is Not Immune After All

Summary:

• Apple’s revenue was weaker than expected due to FX headwinds, difficult macro environment, and supply chain disruptions as a result of Covid-19 restrictions in China.
• Guidance was light as the market was disappointed when the company guided a weak March quarter that will look similar to that of the December quarter.
• Management reiterated that the supply chain is where it needs to be and supply of products is sufficient in the current quarter.
• India presents an opportunity for Apple in the form of growth and an alternative production base.
• I am of the view that earnings revisions from sell-side analysts face downside, and I remain neutral on Apple in the near term.

While I do not think that Apple’s (NASDAQ:AAPL) first quarter of FY2023 was a big disappointment, it did show the rare vulnerability that Apple investors are probably not used to.

I have been neutral on Apple shares for some time. I have written an article warning investors not to add at those levels, following which you would have experienced a 20% fall in the value of your investment.

To summarize, I am not bearish on Apple’s long-term potential. However, I do believe that there is a need for further multiple compression and downside earnings revision for the froth to be removed from the stock.

This article aims to dive deeper into the recent 1Q23 of Apple and identify the difficulties that Apple will face in the near term. I expect Apple shares to trade negatively on the 1Q23 report.

Earnings results

Apple generated $117 billion in revenues in the first quarter of 2023, which is down 5.5% from a year ago. The 1Q23 revenue number was 4% lower than consensus expectations.

There were three reasons highlighted by management that resulted in the weakness of revenues for the quarter. The first reason was an 800 basis point impact from FX headwinds. Stripping this foreign exchange headwind out of the quarter’s results, we would have seen revenue grow year-on-year and most of the markets would have seen positive growth. The second reason was due to the challenges that Apple faced as a result of Covid-19 restrictions in China. As highlighted in Apple’s 6 November update, its facility in Zhengzhou, China was affected as a result of a huge reduction in capacity. This resulted in lower iPhone 14 Pro and iPhone 14 Pro Max shipments than the company previously expected. As a result, customers had to wait longer for their new products. The last reason for the weakness in revenues for the quarter was, according to Apple, due to the difficult external macroeconomic environment. Management quoted unprecedented happenings, like inflation, Russia’s war in Ukraine, and the pandemic.

In my view, this last bit is where it gets interesting. It seems to me that management is trying to convey to the market that Apple too, is not immune, as so many think. I think the company is trying to communicate about the vulnerability that Apple faces in the current difficult macro backdrop.

This implies to me further weakness in the coming quarters and likely need for further sell-side EPS downward revisions.

In terms of segment revenues, products revenue was down -8%, to $96.4 billion, missing consensus by 3% while revenues for the iPhone came in at $65.8 billion, 4% below consensus expectations. This was due to the material supply chain disruptions that occurred in the quarter.

Interestingly, services revenue brought a positive surprise as it grew 6% year-on-year in the quarter, 4% above market expectations.

Greater China’s revenue came in at $23.9 billion, down -7% year-on-year, while beating expectations by almost 9%.

Gross margins came in at 43%, in line with consensus expectations.

EPS came in at $1.88, down 10% from the prior year and missing consensus expectations by 3%.

The main negatives then came in the company’s guidance for the March quarter, which was weaker than expected.

Guidance

Apple did not provide guidance again as it continues to see macro challenges and uncertainties in the near term.

For its March quarter, Apple expects that the revenue year-on-year growth will be similar to that seen in the December quarter. This implies about -5% revenue growth for the March quarter, similar to that of the December quarter.

Foreign exchange will still be a headwind for the business, resulting in a 5-percentage points headwind for the business in the March quarter.

For the iPhone segment, management expects that the March quarter will see an acceleration in terms of revenue year-on-year growth relative to the December quarter. For the Services segment, management expects revenue to continue to be resilient and grow in the March quarter. Lastly, for Mac and iPad, management expects that a high base and macroeconomic challenges will result in these two categories to experience double digits year-on-year.

On gross margins, Apple expects to deliver gross margins between 43.5% and 44.5% in the March quarter, while operating expenses are expected to be between $13.7 billion and $13.9 billion. Its OI&E is expected to come in at around negative $100 million.

Supply chain issues

In terms of the supply chain issues Apple faced from early November until the end of December, management mentioned that they are now at a production level where they “need it to be“, and that the supply chain “problem is behind us”.

Apple is looking to optimize its supply chain, given that it has component parts coming from many countries globally.

Currently, the company is in decent supply for most products, which looks to be positive for the March quarter.

Apple is diversifying its supply chain. For example, some of Apple’s MacBook production was moved to Vietnam in 2023 for the first time ever.

In addition, Apple announced that they have started producing iPhone 14 in India. While India has been manufacturing iPhones for Apple since 2017, this was the first time Apple is producing its latest model in India. This comes as Apple looks to diversify its supply chain and shift some of its production away from China to prevent future supply chain issues like the one experienced in the recent quarter.

India’s opportunity for growth and supply chain

Management appears bullish on India as Apple reached a quarterly revenue record in the country in the quarter, as well as its highest-ever revenue from iPhone for India. Management is excited about the huge opportunity Apple has in India given the traction it has seen thus far, and the company is looking to invest heavily into India in the future.

India will be a key source of growth for Apple, as well as an alternative production base. Although Apple currently does not have any retail stores in India yet, there are signs they are looking to do so as the company has begun hiring retail store workers in January.

Final thoughts

I have been sending early warning signs to investors about Apple’s potential vulnerability. Expectations have been too high and when people think that Apple is immune, it is bound to fall.

I think this 1Q23 quarter showed Apple’s investors that it is not immune. It is not immune to supply chain disruptions. It will be negatively affected by the macro environment like inflation and the pandemic.

I think the next step for Apple is the wave of earnings downgrades that will come after the current earnings report. It does not mean that Apple is uninvestable, nor does it mean that Apple has no long-term potential. It just means that there is near-term downside to come, and I would remain neutral until things have settled down.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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