Image Source: Aaron Yoo
Apple’s strength was on full display in its second quarter of fiscal 2018 as it beat expectations on a number of quarterly measures and delivered a significant dividend increase. The company remains one of our favorites on the market today. Our fair value estimate currently sits at $201 per share.
By Kris Rosemann
What more can we say about Apple (AAPL) after a quarter in which it beat consensus expectations on revenue, earnings per share, iPhone and iPad shipments, and Services revenue, as well as had the ability to raise its quarterly dividend by 16% and authorize an additional $100 billion for share repurchases? We reiterated our positive long-term view on Apple on April 20, “Reiterating Our Positive View on Apple,” as sell-side analysts once again began to fret over the tech giant’s performance, mostly related to concerns over the trajectory of iPhone sales. The company’s brand strength, presence in consumers’ lives, top-notch balance sheet health, and its robust free cash flow generating capacity showing no propensity to slow anytime soon, are all core to our thesis.
Apple blew iPhone-related concerns away–at least for now as this struggle between the firm and some portions of the analyst community may never go away–as iPhone revenue grew 14% in the second quarter of its fiscal 2018, results released May 1. First half fiscal 2018 iPhone revenue set a new first half record, and it achieved the highest first half growth rate in three years as its new iPhone X was the most popular iPhone in that time, marking the first time a top-end iPhone has been the most popular since Apple split the 6 and 6 Plus product lines. iPhone average selling price leapt to $728 in the quarter from $655 in the comparable period of fiscal 2017.
Overall revenue grew 16% from the year-ago period thanks in part to a record fiscal second quarter for Services, where revenue has doubled over the past four years after turning in 31% growth in the fiscal second quarter. The segment now has more than 270 million paid subscribers, illustrating the vast reach of Apple’s impressive ecosystem and combination of incredibly appealing hardware and powerful software. Apple’s Wearables business is another example of its broad appeal as revenue jumped nearly 50% in the fiscal second quarter, and the business is now the size of a Fortune 300 company.
Growing Services revenue also bodes well for Apple’s gross margin, which was relatively flat in the quarter as seasonal weakness was offset by cost improvements and the increased mix of Services revenue. Diluted earnings per share jumped 30% on a year-over-year basis in the quarter to $2.73 thanks in part to a lower tax bill, and the company’s free cash flow generation is as robust as ever as fiscal first half free cash flow advanced nearly 9% over the year-ago period to $36.4 billion.
Apple’s cash balance of $267.2 billion is a significant source of strength compared to total debt of $121.8 billion, but management reiterated its plan to target a more optimal capital structure that will have a significantly higher degree of financial leverage as it works to get its balance sheet to cash-neutral. While we cannot disagree with the idea of the company working to lower its weighted-average cost of capital by increasing financial leverage to its optimal capital structure, we’re still not convinced abandoning the tremendous financial strength and optionality that comes with a robust net cash position on the balance sheet is the best move.
Nevertheless, we continue to like the long-term outlook for Apple. Its 16% dividend hike announcement was as appropriate as ever–dividends paid in the first half of fiscal 2018 came in at ~$6.5 billion, covered several times by free cash flow–and management is as confident as ever in its future performance and the trajectory of its stock as the board authorized another $100 billion in share repurchases due to its expectations to complete its current $210 billion buyback program in the June quarter, three quarters ahead of schedule.
We can’t say that we are particularly opposed to the robust levels of share repurchases, considering our fair value estimate currently sits at $201 per share, and the increased dividend implies a yield of nearly 1.7% as of this writing. Shares are on the move towards our fair value estimate following the impressive quarterly results, and we see no reason at this juncture to remove the idea from either of our simulated newsletter portfolios.
Apple suppliers: CRUS, SWKS, LITE, AVGO
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.