Last week, I provided my initial thoughts after we got the major revenue warning from technology giant Apple (AAPL). A combination of the Chinese trade war, high phone pricing, and other factors left the company's results falling well short of estimates for the all-important holiday period. While some investors might think this negative announcement will mark a bottom for shares, the best scenario is likely to wait until the dust truly settles.
As you can pretty much guess, Street analysts have not been too kind in the past couple of days. While some firms had been reducing estimates and price targets in the last month or two, even the most bearish on the Street didn't have Apple with this low a revenue figure for the period or a price target as low as where shares fell to. The graphic below shows how much analysts have cut their price targets on the stock since the bombshell news.
(Source: Apple 3.0 article, seen here)
Now I know that Apple shares bounced more than 4% on Friday as part of an overall market surge. The move kind of reminds me of a rally we saw at the end of November to put Apple shares back in $180. How did that turn out? With the volatility we've seen in markets recently, one or two trading days can easily put shares at a new 52-week low. While the US jobs report was stronger than expected, there's still a lot of potential risks in the current market.
One reason I remain a little worried in the short term has to do with the biggest problem spot for Apple currently: China. There is a prevailing thought out there that Chinese consumers are backing off buying Apple products during this trade war. Next month is the Chinese New Year, which usually is a decent sales time in that country; so without any progress on the trade front, Apple's weakness in China sales could easily continue in the current period.
Unfortunately, we have to look at the numbers from last year as well. Going sequentially from Q1 2018 to Q2 2018, China revenues as a percentage of Apple's total picked up from 20.3% to 21.3%. Also, the China revenue growth rate over the prior-year period went from 11% in fiscal Q1 to 21% in fiscal Q2, so there is a higher comparison bar. Don't forget the HomePod launched in this period a year ago, so if a new version doesn't come in the next month or two, that's another headwind to think about.
We still have a number of estimate cuts likely to come in the coming days and weeks. As of Sunday, the average Street revenue estimate for fiscal Q1 was $87.44 billion, still quite a bit above the $84 billion preliminary figure provided by management. That's a decline of nearly 4.9% over the prior-year period, but analysts aren't close to that number yet either for fiscal Q2 as seen below. Should the China situation not improve quickly, we easily could see a revenue decline in the mid-to-high single-digits, percentage-wise, meaning the Street likely needs to come down further.
(Source: Yahoo! Finance estimates page and Reuters estimates page)
There's also one other smaller item that investors might not be bracing for, and that's lower revenue growth in Apple's services segment. Management announced previously that it was revising how it accounts for certain revenues. The company has provided this handy guide to detail how past periods would have looked under the new accounting method. I've pasted the key part below to show the overall changes.
The services segment got a boost of more than $2.5 billion in reported revenues for fiscal 2018. Thus, when Apple announced a $10.8 billion preliminary figure for services for Q1 2019, investors may have been comparing this to the $8.5 billion number originally reported last year. However, under the new accounting standard, the revised figure for the year-ago period is more than $9.1 billion, so the growth rate will look a lot less impressive. Every quarter from the year-ago period got a more than $600 million boost, which is not small potatoes.
At this point, I'd like to see another weak quarter of results reflected in estimates or significant progress made on the trade front before recommending investors jump in. An interesting way to play shares right now might be to sell the February 22nd $145 puts for about $6. While you won't make money if Apple jumps, you'd make $6 in a month and a half if Apple stays above $145, which is pretty nice for a short time. Also, if the stock tanks, you'd be effectively buying at $139, meaning you'd be protected for more than $9 of downside from current levels.
In the end, I think investors need to wait a bit on Apple before taking a serious look at the stock. We likely will see more weakness out of China in the short term unless the trade war is suddenly settled, and Q2 comparisons are even tougher than the quarter Apple just warned on. With estimates needing to come down further and services growth being reduced significantly by the accounting change, it would not surprise me to see shares retest or make new lows. Let's wait until the dust settles after the full earnings report comes in, then we can analyze the overall situation again.
Author’s additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.