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Apple pushes apps hard as iPhone drags

The stock has soared around 30% this year despite falling earnings

Lowered expectations

One of the most remarkable points about Apple’s third quarter earnings release, which will kick off with possible seismic effect on markets in a while, is how weak they’re expected to be, at least on the surface. A solid Q2 sets Apple up for a turnaround year, especially with worst-case trade risks fading. Yet sales are forecast to be flat at $53.35bn (that would be an improvement on the 5% fall of Q2.) EPS is seen 8.9% lower on the year at $2.10.

Raised hopes

Despite sober expectations, the stock continues to outperform U.S. large-cap stocks. It is some 10 percentage points above the S&P 500’s 20% rise so far this year. The basic takeaway is that the Apple has put more distance between now and late 2018’s fiscal quarter, when handset disappointments and China anxieties were raw. As seen on Tuesday, the White House can trigger a market a mood-swing on its dispute with China at almost any time. But resumed talks lower the risk of levies or other restrictions on iPhone sales in the U.S. and China, even if the long-term threat remains.

Everything but the iPhone

As such, investor views are more constructive going into the $964bn group’s third quarter results, with most focus on non-iPhone segments. In other words, the narrative that Apple has pushed for several quarters, to shift investor thinking away from iPhones, is beginning to take hold. There should therefore be more interest in products new and old, including iPad, Mac, Services and Wearables, Home and Accessories. Combined growth of these categories is expected to be  14.4% in 3Q, according to a Bloomberg-compiled consensus.

Here are the key figures/points to watch in one place (consensus forecasts compiled by Bloomberg)

  • Revenue $53.35bn, flat year-over-year, on weakness in China and a tough comparable quarter in 2018
  • EPS seen down about 10% at $2.096
  • iPhone revenue forecast to fall 10.3% year-over-year
  • Services and wearables, home and accessories expected to rise a combined 20.8%
  • Services alone forecast to grow 21.09%
  • Gross margin expected at 37.7%, in-line with guidance of 37%-38%

Naturally, rosy views could set investors up for disappointment. Like it or not, the iPhone remains Apple’s key product, accounting for 62.8% of fiscal 2018 revenue, so sales volatility will keep hurting for years. The smartphone downturn is inescapable, after all. Global smartphone shipments fell 4.1% in 2018, following a 0.3% drop in 2017, according to IDC and China is leading the fall. These data add intensity—perhaps even desperation to Apple’s— shift towards services. The stock could be dented just as badly if retooled expectations are missed.

The company aims to reach a services revenue target of $48.7bn by 2020, raising the segment’s contribution to about 19% vs. 6.9% in 2018. It should be clear from Q3 results if the goal is feasible.

Possible share price reaction

Option trades point to typical turbulence immediately after Tuesday’s release, though implied volatility for Apple shares is more than two times the longer-term average. Pricing projects a 4.5% swing within 24 hours of third quarter results in either direction. The average of the last eight post-earnings moves is 5%. A bearish aspect of the set-up is that just 11% of open interest expires at the end of this week and puts (bearish options) slightly outnumber calls by 1.25—to-1.


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