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July 28, 2014
Earnings Updates: Apple, Google, and Qualcomm
This quarter I am trying a different approach that hopefully saves clients time and increases readership of the quarterly earnings updates. I will write short paragraphs on several companies at a time as they report highlighting a few key items in the reports and looking ahead to future potential of each stock.
Earnings season is off to a mixed start for Northlake Capital Management. Google (GOOG) had a good report highlighted by improved revenue growth. The stock responded nicely. Apple’s numbers were pretty much in line with expectations during a transitional quarter ahead of new iPhones and many an iWatch to be introduced this fall. AAPL shares have moved up to a new recovery high, not far below the all-time high in the fall of 2012. Qualcomm (QCOM) spoiled the party as despite an excellent report, the company cuts its 2014 outlook due to conflicts with Chinese manufacturers over payment of license fees. QCOM shares dipped about 7% due to uncertainty about future growth in China.
Here is a bit more detail on each report.
The highlight of Google’s report was a pickup in advertising growth. Investors have feared that GOOG has reached a point where its revenue growth rate would gradually decelerate. This is partially due to the maturity of search and also to more competition for advertiser dollars form Facebook, Twitter, and other internet ad platforms. In the latest quarter, top line growth picked up to over 20%. Maybe more importantly, GOOG broke out data on its Google.com website vs. partners sites (partner sites have Google search embedded). Google.com search growth was above 30%. Finally, there was small improvement in ad pricing, which fell 6% vs. street expectations for a 7% decline. Remember that Google desktop ads are priced higher than mobile ads so as the mix has shifted toward mobile search (smartphones and tablets), pricing has come under pressure. Should pricing pressure alleviate as expected, GOOG will get a nice growth benefit. GOOG shares have lagged the market this year, gaining only 5%. I think a move to $630, or 20 times 2015 estimated earnings of $31.50, is in store now that investors are feeling better about sustained top line growth trends.
Apple reported a dull quarter by its usual standards. Actually, a better way to state it is that investors reacted little to Apple’s results, an unusual occurrence. Earnings came in slightly ahead of expectations with revenues just a bit below the Wall Street consensus. The implication here is that profit margins were better than expected and that was exactly the case. Apple shares have rallied sharply this year after a difficult period as investors anticipate a big upgrade cycle related to the larger iPhone 6 and a significant new product category for the iWatch. I believe the stability in gross margins is equally important as the bear case in Apple has been that its profitability would fall as the smartphone market matured and its premium prices would face pressure. Whether through sustained demand or effective cost management, gross margins have consistently held up better than expected over the past few quarters. Higher margins assumed in the future means more earnings power. It also undercuts the bear case which has helped increase confidence and allowed AAPL’s P-E to expand. I think the iPhone 6 upgrade cycle will surprise to the upside driving 2015 earnings above consensus of $7.00. A slight expansion in the P-E and credit for a bit of the balance sheet cash ($27 per share), should drive the shares to new all-time highs around $120.
Qualcomm’s report was particularly frustrating as the results were quite good with demand for its chips and the associated licensing revenue both coming in stronger than expected. Unfortunately, the company announced that disputes with the Chinese government and certain Chinese licensees would lower earnings power over the next few quarters. It appears that an ongoing investigation into Qualcomm’s “monopoly power” has given Chinese smartphone and tablet manufacturers an excuse to withhold license payments. China is QCOM’s most important growth market so even though the impact to revenue is small (Chinese companies use mostly low end chips), the long-term growth rate impact could be large. This has led to compression in QCOM’s multiple as the stock has fallen about 8%. This is an impossible situation to analyze but QCOM has faced license battles before in Japan, Korea, and with Nokia. In all cases, QCOM came out fine. China could be different and the stock likely is in limbo until the situation is resolved. There remains risk other licensees in emerging markets could follow China’s lead. I think the shares have compensated for the China risk as they now trade at less than 14 times forward earnings estimates. QCOM is buying back a lot of stock has a cash rich balance sheet. Northlake plans to wait out the China issues and looks to a very strong iPhone demand cycle to support QCOM shares while we wait.
GOOG, AAPL, and QCOM are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. GOOG, AAPL, and QCOM are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.