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Apple surprised the market by issuing first-quarter 2019 guidance below expectations. The company pointed to weakness in China as the main culprit. We continue to expect heightened levels of volatility, and investors in key American icons that might be impacted by consumer backlash in China should be on high alert. No changes to the simulated newsletter portfolios as a result of the news.
By Brian Nelson, CFA
We had yet another volatile day to kick off the new year. The Dow opened with a near 400-point slide and then jumped considerably mid-session only to barely finish higher. You have to read Value Trap. You’ll know exactly what I’m talking about. In case you missed the announcement, the digital PDF download is now available in the Valuentum store:
https://valuentum.com/store/products/45
Well, we got the shot across the bow today after-hours with Apple (AAPL) warning about its first-quarter 2019 revenue. We recently moved to being fully-invested in the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio, and now we trek the markets with our finger on the put-option trigger. We caught a nice bounce after the holiday swoon, but now we will feel the brunt of the market’s wrath on Apple, as it looks to be trading down about 8% after hours.
We’re not making any changes to the simulated newsletter portfolios as a result of the news, but we do expect a downward revision to our fair value estimate range for Apple. The iPhone maker now expects fiscal first-quarter 2019 revenue of $84 billion, down from the high end of the previous expected range of $93 billion, the latter what the market had been expecting. It is now clear that Apple’s decision to stop providing guidance for individual product sales was a big red flag. Even so, we don’t think we would have altered our “weightings” of the company in either simulated newsletter portfolios.
There may truly be no place to hide in this market, and we continue to believe Apple is a high-quality enterprise. Even though it operates within the fickle land of technology, we’re talking about a company with substantial net cash on the books and tremendous free cash flow generation capacity, and one with an extremely healthy dividend. We don’t like the news, but we’re not panicking. We are, however, getting close to layering on some put options in both simulated newsletter portfolios. We’ll have to see just how bad things get during the trading session tomorrow and into Friday. Any moves at this point would just be a premature reaction.
Apple mentioned four anticipated factors that impacted performance during its fiscal first quarter of 2019 (and one new one). The only one of the four that didn’t play out “broadly in line with (its) expectations” was “economic weakness in some emerging markets.” In CEO Tim Cook’s words, “this turned out to have a significantly greater impact than (it) had projected.” In no uncertain terms, this was China (FXI, MCHI). According to Apple, “most of its revenue shortfall to (its) guidance, and over 100% of (its) year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac, and iPad.” The company also noted there were fewer upgrades within its iPhone product line than expected (the new factor), but the news with China is a big one.
Without a doubt, it looks like US-China trade tensions are having a big impact, and while the market was already getting jittery in December, it appears these jitters haven’t fully played out yet. Apple noted that Chinese economic growth is beginning to slow and that the country’s GDP growth for the calendar third quarter was the second-lowest in a quarter century. Apple also noted that traffic to its retail stores and channel partners in China also declined as the quarter progressed. What this means is that fiscal second-quarter performance may be even worse. This may be the biggest negative. Again, we’re taking all of this in stride.
Apple remains in the simulated newsletter portfolios, as the stock has already been beaten up quite badly. Though we expect a downward revision to our fair value estimate range, shares will still come out undervalued. We’ll only look to get rid of Apple if both its valuation and technical/momentum indicators point in the same direction. Right now, Apple is still looking attractive from a valuation standpoint. The company’s competitive advantages remain firmly intact as well, with a huge installed base, brand name, and lucrative services business.
The bigger story, however, is what Apple’s results suggest for others depending on China, and whether Chinese consumer backlash from the trade tensions is hurting other American icons: Nike (NKE), Yum! China (YUMC), and McDonald’s (MCD). Those that have exposure to luxury good stocks, including Tiffany (TIF) and Michael Kors (KORS) should take note, too. Though seemingly unrelated, it may be worth paying attention to any slowdown in metals and mining if China’s economy starts to head south in a hurry. As I explain in Value Trap, this could be the beginning of the greatest period of stock market volatility we have yet seen.
Watch these markets with me.
Luxury Goods – Established Brands: AVP, EL, LULU, NKE, PHG, PVH, REV, SIG, SNE, UA, VFC
Luxury Goods – Ultra & Aspirational: BID, CFRUY, FOSL, KORS, LVMHF, RL, TIF, TPR
Metals & Mining – Diversified: AG, BHP, CLF, FCX, RIO, SCCO, VALE, WPM
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Brian Nelson 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.