Apple 2Q19 Earnings Expectation Meters

Based on Apple’s revised financial disclosure, the Above Avalon expectation meters have received a makeover for 2Q19 earnings. Unit sales meters have been retired and replaced with revenue meters. In addition, an entirely new expectation meter is being included to reflect Apple’s changing business as non-iPhone revenue now plays a larger part in Apple’s growth story.

Estimates

The following table contains my Apple 2Q19 estimates.

The methodology and perspective behind the preceding estimates are found in my 3,400-word Apple 2Q19 earnings preview available here exclusively for Above Avalon members. (To become a member and access my full earnings preview, visit the membership page.)

I am publishing three expectation meters for Apple's 2Q19:

  1. iPhone revenue

  2. Non-iPhone revenue

  3. 3Q19 revenue guidance

iPhone Revenue

My expectation is for Apple to report continued weak iPhone revenue growth in 2Q19 as the company spent much of the quarter working through an iPhone channel inventory build that took place in 1Q19. This channel inventory headwind was partially offset by Apple’s move to cut iPhone pricing outside the U.S. and more attractive offers for iPhone upgrades in the U.S.

While Apple is no longer disclosing iPhone unit sales, the company will continue reporting iPhone revenue. Accordingly, in order to estimate revenue, one will have to derive estimates for iPhone unit sales and average selling price (ASP).

Apple provided some clues regarding iPhone sales mix in order to reach more reliable estimates for ASP. In addition, the company’s not-so-secret strategy of cutting iPhone pricing outside the U.S. will impact ASP. Refined modeling work when it comes to iPhone channel inventory changes will lead to more accurate estimates for iPhone unit sales. Given the moving parts, there will likely be a wider-than-usual discrepancy when it comes to iPhone revenue estimates as analysts with less robust Apple earnings models struggle to adapt to changes in disclosure.

iPhone revenue that exceeds $33B would be considered strong as it bodes well for Apple to report improved iPhone sell-through (i.e. customer) demand in the second half of 2019. However, iPhone revenue of less than $30B would point to continued problematic iPhone sell-through demand.

Non-iPhone Revenue

For the first time, non-iPhone revenue is receiving its own Above Avalon expectation meter. Apple’s non-iPhone revenue includes the following line items:

  • Services

  • Mac

  • Wearables / Home / Accessories

  • iPad

One of the major themes from Apple’s 1Q19 earnings is that despite weak iPhone sales, the company’s non-iPhone side of the business performed well with 19% revenue growth, driven by robust wearables and Services growth. In addition, the Mac and iPad product categories demonstrated stabilization. Much attention will be given to monitoring whether or not this trend continued in 2Q19.

My expectation is for Apple to report $27B of non-iPhone revenue. A revenue number north of $29B would be considered strong while a number less than $26B would be on the weak side.

Guidance

Consensus is calling for Apple to report $52B of revenue in 3Q19. My estimate is for Apple to announce 3Q19 revenue guidance in the range of $52B to $55B. There are two possible explanations for the difference: Wearables revenue expectations and different estimates for iPhone sell-through demand.

Additional information on my perspective and thoughts heading into Apple’s 2Q19 earnings are available in my full earnings preview, which contains three parts:

  1. Setting the Stage

  2. iPhone, Services, Mac, Wearables / Home / Accessories, and iPad Estimates

  3. 3Q19 Guidance, Updated Apple Earnings Model, Final Thoughts

To access my earnings preview and receive my Apple earnings review in your email inbox later this week, sign up at the membership page

Above Avalon Podcast Episode 146: Tackling Apple's Excess Cash

In what has become an annual trend, Apple uses FY2Q earnings to also update its share buyback authorization and quarterly cash dividend. In episode 146, we preview the changes Apple will likely announce to its capital return program. The discussion begins by going over how Apple has adjusted its buyback pace following U.S. tax reform and why the company will eventually have to cut back on buyback. We then go over my expectations for what Apple’s board will approve in terms of increases to the buyback authorization and quarterly cash dividend. Additional topics include the debate surrounding Apple capital return and why the company has so few viable options for spending excess cash.

To listen to episode 146, go here

The complete Above Avalon podcast episode archive is available here

Apple's $400 Billion Buyback Program

One of the more certain items found with Apple’s upcoming 2Q19 earnings is that the board will approve increases to the company’s share buyback authorization and the quarterly cash dividend. The two capital return initiatives continue to be polarizing topics as Apple holds more than $100 billion of excess cash on the balance sheet. A closer look at Apple’s buyback and dividend trends suggests the company’s board still has a strong incentive to increase Apple buyback authorization in a big way next week.

Capital Return Trajectory

Exhibit 1 highlights the amount of cash Apple has spent on capital return (buyback, cash dividends, and net share settlement) on an annual basis since 2012:

Exhibit 1: Apple’s Capital Return (Annual)

Prior to U.S. tax reform, Apple had been spending approximately $50 billion annually on capital return initiatives. The total was funded by a mixture of free cash flow and debt issuance. Once Apple was able to bring its foreign cash back to the U.S. at a favorable tax rate, the pace of capital return increased materially. Last year, Apple spent $90 billion on share buyback, cash dividends, and net share settlement.

Assuming Apple doesn’t spend a significant amount of its excess cash on M&A, the company has enough cash to continue spending nearly $100 billion on capital return annually for at least the next two years. Kicking off between $50 billion and $60 billion of free cash flow annually, Apple ends up utilizing approximately $40 billion to $50 billion of its excess cash on capital return initiatives each year. Over the long run, Apple’s current business footprint supports an annual capital return budget of closer to $50 billion.

Share Buyback

Next week, Apple’s board will approve the seventh consecutive increase to the company’s share buyback authorization. Here are the changes to Apple’s share buyback authorization since the program launched in 2012:

  • 2012: $10 billion buyback authorization 

  • 2013: $60 billion (increase of $50 billion)

  • 2014: $90 billion (increase of $30 billion)

  • 2015: $140 billion (increase of $50 billion) 

  • 2016: $175 billion (increase of $35 billion)

  • 2017: $210 billion (increase of $35 billion)

  • 2018: $310 billion (increase of $100 billion)

Last year, Apple’s board approved a substantial $100 billion increase in share buyback authorization. This was double the amount of the previous record increase in buyback authorization.

At the end of December, Apple had $63 billion of share repurchase authorization remaining. This is another way of saying that Apple had worked through $247 billion of its $310 billion share repurchase authorization. Assuming Apple bought back $20 billion of shares in FY2Q19 (January to March 2019), the company likely had closer to $43 billion of authorization remaining at the end of March.

When estimating the potential increase in Apple’s share buyback authorization, one has to look at the company’s intended buyback pace. Following U.S. tax reform, which opened the floodgates for Apple’s foreign cash being used to fund capital return initiatives, Apple had been on pace to buy back approximately $80 billion worth of shares annually. This elevated buyback pace was interrupted in FY1Q19 following the sudden and dramatic drop in product demand in China. In December 2018, Apple didn’t buy back any shares. However, based on Apple’s 1Q19 10-Q, it looked like Apple had begun buying back shares in January.

Assuming Apple continues to target a share buyback pace of approximately $80 billion per year, the implication is that Apple’s board will need to approve another substantial increase in share buyback authorization next week. An increase of less than $50 billion in additional share buyback authorization would imply a potential slowdown in Apple’s buyback pace. This would be a surprising move considering the significant amount of excess cash that remains on Apple’s balance sheet. In addition, management continues to reiterate its intention of reaching net cash neutral over time, which means the amount of cash on Apple’s balance sheet equals the amount of debt.

Accordingly, my expectation is that Apple’s board will approve an increase in buyback authorization in the range of $75 billion to $100 billion. This will bring Apple’s overall buyback authorization to approximately $400 billion. There isn’t much of a difference between a $75 billion and $100 billion increase in authorization. Both totals would give Apple plenty of flexibility to pursue an aggressive share buyback strategy. A $75 billion increase in authorization would provide Apple approximately $115 billion of available authorization for buyback while a $100 billion would equal more like $140 billion of available authorization. Both of those totals assume Apple repurchased $20 billion of shares in FY2Q19.

Quarterly Cash Dividend

Given how much press and attention is given to Apple’s share buyback, the company’s cash dividend story continues to fly under the radar. Apple’s board has approved six consecutive increases to the quarterly cash dividend. Next week, the company will announce its seventh consecutive increase.

Here is Apple’s dividend history since reinitiating the dividend in 2012:

  • 2012: $0.38 per share

  • 2013: $0.44 (15% increase)

  • 2014: $0.47 (8% increase)

  • 2015: $0.52 (11% increase)

  • 2016: $0.57 (10% increase)

  • 2017: $0.63 (11% increase)

  • 2018: $0.73 (16% increase)

When gauging the magnitude of the upcoming quarterly cash dividend increase, a 10% increase likely represents a floor. There are two reasons behind such an assertion:

  1. Dividend strategy. Apple follows a stable dividend policy characterized by a steady dividend payout that reflects its long-term earnings potential. Instead of dividends closely following near-term earnings swings, the two variables align when looking at long-term trends.

  2. Apple’s share buyback pace. As Apple buys back shares, the company pays out less in the way of cash dividends. This is made possible because repurchased shares are retired, reducing the number of outstanding shares. For every 100 million shares that Apple repurchases, the company saves approximately $300 million on cash dividends per year. Since reinstating the dividend, the amount of cash that Apple has spent on dividends has increased by 30% while the quarterly cash dividend has increased by 92%. As long as Apple continues to buy back significant amounts of stock, the company will be able to increase the quarterly cash dividend by 10% and not actually incur additional dividend expense.

(For an in-depth examination into Apple’s dividend strategy, check out the Above Avalon Report: Apple Dividends: A Deep Dive into Apple’s Cash Dividend Strategy. The report is available exclusively to Above Avalon members. To read the report, become a member here.)

With the preceding two variables in mind, my expectation is that Apple’s board will approve a 14% increase in Apple’s quarterly cash dividend to $0.83 per share, up from $0.73 per share.

Cash Spend

With more than $100 billion of excess cash on the balance sheet, there continues to be a vocal group advocating that Apple spend the cash on something other than capital return. However, the item that is often ignored by those advocating that Apple cut back on buyback and dividends is that management is already spending tens of billions of dollars each year funding organic growth opportunities.

In FY2018, Apple funded the following items:

After taking into account the preceding organic growth investments and expenditures, Apple was still left with approximately $50 billion of free cash flow. It is this free cash flow, in addition to the excess cash already on the balance sheet, that is funding the company’s capital return initiatives:

  • Buyback: $73.0 billion (in FY2018)

  • Cash Dividends: $13.7 billion

  • Net share settlement: $2.6 billion

  • Total: $89.3 billion

Piling additional cash into R&D simply as a means of spending excess cash doesn’t make any sense. The same philosophy applies to capex. Apple’s business model is capex light. There is no logic found in Apple moving away from this model just to spend more cash. Even if Apple doubled R&D and capex overnight, which isn’t going to happen, the company would still have tens of billions of dollars piling up on the balance sheet each year.

This leaves M&A as the only other way for Apple to spend the excess cash. While Apple is certainly in a position to fund additional M&A activity, including acquisitions with larger price tags, there is no logic in the company changing its M&A philosophy because it has excess cash. Acquisitions don’t suddenly become more rational simply because the acquirer has excess cash that it wants to remove from the balance sheet. Instead, Apple continues to look at M&A as a tool for acquiring technology and talent in order to plug crucial holes in its asset base.

Given the lack of attractive alternatives, Apple’s board still has the incentive to continue approving substantial increases to share buyback authorization and quarterly cash dividends.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members. To sign up and for more information on membership, visit the membership page.

Above Avalon Podcast Episode 145: It's All About Curation

At Apple’s recent event at Steve Jobs Theater, the company unveiled its revamped content distribution arm. Episode 145 is dedicated to discussing Apple’s new content distribution services: Apple News+, Apple Arcade, and Apple TV+. Instead of just announcing services for consuming more content, Apple unveiled a strategy for curating content for its user base of a billion people, something that I am calling “Curation for Casual.” The discussion also goes over how curation explains Apple’s move into original content. Additional topics include a few surprises unveiled at Apple’s Services event, the history behind Apple’s video distribution strategy, the changing content consumption landscape, and Apple’s content distribution arm eventually being considered a core technology powering Apple devices.

To listen to episode 145, go here

The complete Above Avalon podcast episode archive is available here