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Investing, Stocks, Trading  | January 24, 2019

This could be the most important earnings release of the past several quarters for Apple (AAPL).

In just about a week, on January 29th, the Cupertino-based company is scheduled to report the results of the crucial holiday season. Regarding the quarter itself, the edge has been taken off, following the company's earnings warning issued early in January. It is no secret anymore that revenue contraction of -5% will be a huge disappointment to those who, as recently as October 2018, expected to see a +5% YOY increase in total company sales instead. The important iPhone and China units will probably look very weak, with segment revenues lower YOY by what I estimate to be -15% and -23%, respectively.

This is what is known or reasonably predictable about fiscal 1Q19 (see projected results table below). But what will make January 29th an important day for AAPL investors, in my view, will be the more nuanced outlook for the next few quarters. More specifically, I will be paying close attention not only to fiscal 2Q19 guidance but also to management's sentiment about the global economy and Apple's prospects within it, and whether softness in the holiday quarter may linger longer into the new year.

(Source: D.M. Martins Research, historical data from company reports)

As I mentioned back in September 2018, the more realistic AAPL investors (even the more bullish ones) should expect a significant slowdown in iPhones sales growth over the next several quarters. The tough comps of double-digit YOY increase that will have an impact on growth metrics in fiscal 1Q19 and throughout the year only begin to tell the full story. I also expect the declining sales growth trend to be fueled by (1) a period of late-stage maturity in the smartphone space, and (2) a potential deceleration in global economic activity as the effects of loose monetary and fiscal policy, particularly in the U.S., runs its course.

The more important question in my mind is the extent of the iPhone sales growth tapering. As of now, I continue to project device revenues heading to more sustainable mid-single digit growth levels by the end of fiscal 2019 (see orange dotted line in the chart below, on the right), although the recent earnings warning may suggest too much optimism on my part. A more subdued read of the challenges experienced in Greater China and other emerging markets, for example, could turn me a bit more cautious on my current year projections.

(Source: D.M. Martins Research, using data from company reports)

The other very important piece of the puzzle, in my view, will be the projected evolution in service revenues. As of now, I continue to be highly confident in Apple's ability to double this segment's sales by fiscal 2020 over 2016 levels, to represent nearly 20% of total company revenues by then. Supporting my bullishness is CEO Tim Cook's remarks that (1) despite the disappointing performance in iPhones, non-smartphone revenues are expected to rise by 19% in fiscal 1Q19, and (2) the installed base continues to grow YOY, even if timidly and despite unfavorable factors like lower carrier incentives.

However, I cannot rule out the possibility that potentially lower consumer discretionary spending might push service revenue growth below the 20% mark in the current fiscal year. The more bearish analysts have even called the segment "the next shoe to drop", which I find a bit overly dramatic. But there is significant risk to the investment thesis, in my view, if what is hoped to be the main offset to declining iPhone sales fails to inspire. Should the headwinds pressuring iPhone sales (e.g., softness in China, a strong dollar) also have a noticeable impact on services in the foreseeable future, it could become substantially harder to justify bullishness on AAPL, even at current valuations that I consider highly de-risked.

See the historical service revenue trend below, along with my projected path (blue dotted line) to double sales by fiscal 2020.

(Source: D.M. Martins Research, using data from company reports)

Key Takeaway About the Stock

Amid macro and company-specific challenges, particularly in the iPhone and emerging market segments, it has become increasingly tough to make short-term predictions about Apple's performance. I was never much of an AAPL trader, having owned the stock since I started researching and writing about it. Now I am even less tempted to making judgement calls about quick entry and exit opportunities on this stock.

But over the long run, I continue to find AAPL a solid buy-and-hold name for most growth portfolios. True, the recent news has not been favorable, and risks certainly exist (and seem to be even more significant than they were a mere three months ago). But as shares trade at a current-year P/E of only 12.9x (the lowest of the past 12 months, see graph above) and long-term PEG of 1.2x (also a recent low), I believe quite a bit of the bearishness has already been priced into this stock.

Therefore, I continue to find AAPL a name well worthy of consideration, even if shares get tossed around a bit by near-term worries over the company's operational and financial performance.

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