of Apple Inc. (NASDAQ:AAPL) The publication of results for the fourth quarter of the year saw many loyal Apple followers excited about the resilience of the Cupertino company, while its tech peers faltered.
However, investors who looked at his earnings feedback and segment metrics would have gotten several red flags that should not be missed. iPhone was strong as it launched its iPhone 14 series recently. Apple investors are well aware that their FQ4 is a seasonally strong quarter due to the timing of their iPhone launch. So we wouldn’t focus too much on how FQ4 works per se. Instead, we will discuss why we see significant headwinds in the next two quarters that Apple bulls may not have carefully considered relative to Apple’s unsustainable valuation.
We will take a close look at the forward guidance/commentary on how Apple sees its future outlook. The market is not focused on past data/releases, but on what it anticipates Apple’s future performance could be.
Our analysis indicates that the post-earnings rally looks more and more like a move to catch Apple traders/bulls in another trap before digesting those gains. Some investors get caught up in pre- and post-earnings moves without carefully evaluating the price action of their overall pricing structures. Consequently, we remain convinced that AAPL’s medium-term uptrend, which we will discuss in the article, has been lost.
We discuss why AAPL’s valuation at current levels is unsustainable. Furthermore, it appears to have been downgraded, which is another early warning sign that a steeper drop could be on the way for careless Apple bulls not paying enough caution to their valuations.
Accordingly, we are revising our AAPL rating from Hold to Sell and urge investors to use the rally to reduce exposure.
Where is the tracking for iPhone?
Apple investors should be well aware that any serious discussion can never prevent the performance of its three most critical revenue drivers, as seen above.
There’s no question Mac outperformed in 2022, as its share of revenue rose to 12.8% in Q4. Together with iPhone and services, they accounted for 81.3% of Apple’s FQ4 revenue, up from 81.6% in FQ3. However, it is higher than Q4 2021 revenue share of 79.6%, when Mac accounted for 11% of revenue. Therefore, we will have to address whether the superior performance of the Mac in FQ4 can sustain its growth in the future.
With the iPhone accounting for 47.3% of the FQ4 revenue base, the Apple bulls would have been heartened to learn that iPhone revenue grew 9.7%. But that is well below last year’s 47% growth. Management attributed the strength of iPhone revenue to upgraders and switches, implying that it has continued to gain market share. However, we would not encourage investors to read FQ4 figures for Apple too much, given its seasonal distortions.
In particular, we urge investors to consider what FQ1 might look like as Apple enters its first full quarter of iPhone 14 series sales. Advance management commentary (not guidance) suggests that it sees “year-over-year revenue performance will slow down during the December quarter [FQ1’23] compared to September quarter [FQ4’22].”
Well this is what it looks like. Apple iPhone FQ1’22 revenue grew 9.2% year over year. Thus, the iPhone 13 had a fairly strong full quarter of performance, but still fell short of the 17.2% growth in Q1 2021, as seen above.
Note that Apple FQ4’22 overall revenue grew 8.1% year over year. Thus, it suggests that iPhone revenue growth is likely to continue to trend downward even as it gains share against its competitors. As a result, we think it will continue to be more difficult for Apple to overcome it.
Meanwhile, Mac performance is unsustainable. Apple has outperformed its Windows peers by posting a remarkable 25.4% growth in Mac revenue in the fourth quarter. However, management commentary suggests that “Mac revenue will decline substantially year-over-year during the December quarter [FQ1’23].”
As a reminder, Mac delivered $10.9 billion in revenue for FQ1’22, up 25.6% from YoY. So that Mac tailwind is presumably gone. So it suggests that Apple is not immune to the significant consumer electronics headwinds that have hit the PC market. Apple’s comment suggests that it sees these headwinds continuing. Supply chain sources indicate that inventory digestion in the PC channel could continue into the second half of 2023. But that’s inventory digestion. Demand recovery is another matter.
in a recent commentBloomberg’s Mark Gurman noted that Apple could be ready to launch its MacBook with new M2 chips at TSMC (SST) 3nm process nodes in early 2023. So Apple could be looking to power its Mac segment in time for the FQ3 reports. We’ll see how that goes, but we think investors shouldn’t put too much emphasis on expecting Mac to lead again anytime soon.
What about the services?
Before investors get too excited about Apple’s recent subscription price hike, Loup Ventures Estimates indicate a 1% accrual in net income “over the next year.” Of course, Apple’s ability to raise prices is often taken for granted, but it’s a result of its competitive moat built over time. However, we wouldn’t be too excited about a 1% rise for now, as AAPL shares are priced at a steep premium.
Services grew 5% year-on-year in the fourth quarter, continuing a downward trend that peaked in the third quarter of 2021, as seen above. So is it going to bottom out eventually? Nothing falls in a straight line. But maybe not in the short term.
Management’s commentary suggests that services could continue to be under pressure due to significant macro challenges, including the foreign exchange market. However, we urge investors to consider forex tailwinds/headwinds as a single package. For companies with substantial global exposure, it’s just an integral part of doing business. It is inherent to the business model. When did people complain about forex being a tailwind before? We don’t remember if there were any.
So Apple’s most important growth engine could be experiencing a structural slowdown, even if it bottoms out afterwards. So what’s next in line? If you’re buying Apple for “optionality,” you might want to consider the following, as Loup Ventures’ Gene Munster points out:
Apple has growth options in three potential markets that I’ve talked about earlier. This includes health, AR, and auto. One of these three opportunities is likely to materialize and set the company up for another decade of strong performance. – Loup Ventures
For now, we focus on what we can see. Why? AAPL is not cheap. It is too expensive to buy only for optionality.
Is AAPL Stock Buy, Sell, or Hold?
AAPL last traded at an NTM EBITDA multiple of 18.7x, well above its 10-year average of 11x. Also, note that AAPL has been unable to gain momentum above the two standard deviation zone above its 10-year mean.
Therefore, the market has apparently “refused” to follow the AAPL bulls because of their optimism that AAPL deserves to be rated at a significant premium to the market and its peers.
Based on its forward EBITDA multiples through FY25, it’s clear that Apple is not a growth story. Even optimistic Street analysts don’t believe Apple can deliver massive profitability growth over the next three years to “reduce” its forward EBITDA multiples.
We think the market knows that AAPL is not a growth story. And therefore, its valuation is unsustainable at current levels.
Therefore, we posit that the easy money in AAPL has already been made. If you jump on the bandwagon now, we assess the risk-reward profile to be very unattractive.
Note that AAPL has already lost its medium-term bullish bias. It is not unusual for AAPL to stage a relief rally from an oversold September low (yes, the rally already started three weeks ago, not last week). The critical question is where this rally could stall.
We urge investors to keep an eye on its short-term resistance, noted on the chart above. So it doesn’t hurt to take some exposure off if you have massive profits. Given the tech bear market, there are plenty of alternatives to choose from.
As such, we revised our AAPL rating from Hold to Sell.