Apple earnings: Solid results as next wave of iPhones on deck

 

Wide-moat Apple (NAS: AAPL) reported solid results for its fiscal third quarter and provided investors with a flattish outlook for the September quarter. We continue to take Apple’s results in both the June and September quarters with a grain of salt, as results are composed of the older iPhone series and we would instead keep our eyes on the next wave of Apple devices and whether Apple can entice a larger portion of its customer base to buy the latest and greatest iPhone.

We maintain our fair value estimate of $150 per share and view shares as overvalued. We’re encouraged by Apple’s success in reaching 1 billion paid subscribers for its services businesses, but still struggle to foresee the company as being more than a mid- to high-single-digit revenue grower in the long term.

Encouraging shifts to iPhones from Android

Revenue in the June quarter was $81.8 billion, down 1% year over year as reported, but up on a constant-currency basis. The iPhone revenue performance was similar, down 2% year over year as reported but up in constant-currency terms. We’re encouraged that Apple saw a June-quarter record in switchers to iPhone and away from Android.

Services revenue was the bright spot, up 8% year over year and ahead of expectations, with June-quarter records in several subsegments like video and payment services. The iPad and Mac revenue continue to struggle after a natural slowdown in these markets post-COVID-19 lockdowns, as revenue was down 20% and 7% year over year, respectively. Apple remained highly profitable with a record high gross margin of 44.5%, up 20 basis points sequentially.

In the September quarter, Apple expects revenue to be flattish on a year-over-year reported basis. On the upside, iPhone and services year-over-year growth should accelerate and currency headwinds should dissipate. However, Apple expects iPad and Mac revenue to be down at least 10% year over year because of tough comparisons to a strong September 2022 quarter.

Apple’s AI investments

We see virtually all tech companies being asked about artificial intelligence. On this front, we heard Apple discuss its investments in AI and machine learning and how it is integrated into many of its products already.

Generative AI, such as ChatGPT where the AI generates new content rather than surfaces patterns within existing data, is also an area where Apple is investing, albeit secretly. Ultimately, we foresee a host of niche or customized generative AI models being infused into software and platforms over time, and Apple’s work here is no exception.

We would speculate that any sort of co-pilot functionality would make sense to us within Apple’s suite of products, given all of the services Apple layers within its devices and its integration across various form factors.

Amazon earnings: Strong Q2 and better-than-expected outlook

 

Wide-moat Amazon (NAS: AMZN) reported strong second-quarter results and provided better-than-expected guidance for the third quarter.

E-commerce and advertising drove most of the upside, but AWS revenue stabilized and came in better than feared with a more upbeat outlook. Operational improvements continue apace and propelled the firm to its strongest operating margin in the last two years.

We still envision healthy long-term growth driven by e-commerce proliferation, AWS, and advertising and believe the biggest near-term issue is evolving to be the health of the consumer rather than business spending on the cloud. After increasing our growth and profitability assumptions based on results and guidance, we are increasing our fair value estimate to $150 per share, from $137 previously, and see modest upside for the stock.

We see plenty of green shoots within segment performance. Second-quarter revenue grew 11% year over year both as reported and in constant currency, to $134.4 billion, compared with the high end of guidance at $133 billion. The two most critical segments, AWS and advertising, grew 12% and 22% as reported, respectively, over the year-ago period.

Amazon’s growth in this category continues to outpace that of its large internet peers.
Relative to our model, online stores, third-party seller services, or 3P, and advertising drove the vast majority of upside. Physical stores were in line while all other segments were slightly ahead. From a retail perspective (all year over year, as reported), revenue from online stores grew 4%, physical stores grew 6%, 3P grew 18%, and subscription services increased 14%. Paid unit growth accelerated modestly to 9% year-over-year growth.

Operating profit came in at $7.7 billion, compared with the high end of guidance at $5.5 billion, resulting in an operating margin of 5.7%, compared with 2.7% a year ago. Both North American and AWS margins expanded sequentially, while international continues to narrow its losses.

AWS stabilizing

AWS was our biggest concern from last quarter, and we were pleased to hear about stabilization during the quarter and through July, as optimization efforts are easing, and new workloads are taking hold. This is consistent with commentary from Microsoft regarding recent Azure performance. Management remains optimistic on AWS and is continuing to invest heavily in the segment. We continue to believe that the migration to the public cloud is an enormous opportunity and remains in the early stages of evolution, with AWS being the clear leader.

We think the company has entered a second phase of margin improvement after the massive expansion during COVID-19 and the resulting issues that followed as the lockdowns subsided. Now the company has moved to a regional fulfilment model, which has helped speed delivery times and lowered costs. Amazon continues to make progress on margins on a variety of fronts and we expect including improvements to the productivity of the fulfillment network and transportation, but also throughout the entire business as well.

Amazon’s AI prowess

Like nearly all of our coverage, management discussed its artificial intelligence initiatives, noting it has been in the AI and machine learning business for years already—a point we regularly reinforce with clients.

Amazon noted its prowess in AI, including more than 25 AWS services; two internally designed chips; Bedrock, its own managed AI service; and Titan, its own family of large language models. AI is clearly embedded in much of what Amazon has built over time, so we fully expect the company to be a leader in AI, especially given the cost and compute capacity required to build, train, and run these models. Management is rightfully optimistic the company will be a leader in this category, a point with which we agree.