Apple (AAPL) reported solid 3Q18 results and issued slightly better than expected guidance for the September quarter.  The stock should be in good shape heading into this fall’s new iPhone launch.  Northlake intends to hold AAPL shares in client accounts but some small sales could occur due to position size management.   A move up to $220+ seems plausible based on an elongated iPhone cycle, continued growth in services and wearables, and buyback driven EPS growth.  We arrive at our price target based on 15 times what we expect to be $14 in EPS in 2019 plus modest credit for almost $30 in net cash per share still on the company’s balance sheet.  Upside could exist if AAPL’s multiple expands as service and wearables continue to grow rapidly or if the large installed base of older iPhones begins to upgrade a little more rapidly once the entire lineup shifts to the X form factor with a greater array of screen sizes and price points.  Northlake sees both outcomes as highly plausible.

In the most recent quarter, iPhone unit sales were a little light though inventories were drawn down more than normal such that underlying demand was likely in line with street expectations.  iPhone revenues grew 20% despite just a 1% gain in units shipped as the higher priced iPhone X has lifted average selling prices.  Eventually, the large installed base of older phones will have to upgrade to sustain iPhone revenue growth.  We are hopeful that a full lineup of X form factors including a normally priced LCD screen and a plus size OLED screen will boost upgrades.  Northlake and many other investors had hoped for a super cycle based on the iPhone X.  This did not occur as consumers have shown a willingness to use their phones much longer – after all, functionality is quite good even on three year old phones – and balked at the $1,000 price tag on the only option to upgrade.  An elongated cycle could now happen given a broader area of form factors and price points.

The installed base of iPhones users may only be growing slowly but iPhone owners are spending more and more money on Apples services and wearables.  Services grew 29% adjusted for a one-time benefit, continuing a string of high growth quarters.  Apple Music, iCloud storage, Apple Pay, and the App Store are driving this growth.  Penetration of many of these services is still low, so growth should continue even as comparisons stiffen in calendar 2019.  Wearables are also benefiting from the installed base.  Apple Watch got off to a slower than expected start but is now growing rapidly since the watch added cellular connectivity and focused its marketing on health and fitness.  AirPods have been a big hit right from the start.  Services plus wearables are over 20% of revenue on an annualized basis.  These businesses are accretive to gross margins and drive mid-single digit revenue growth for the entire company even if iPhone revenue decelerates and eventually flattens out.

Finally, AAPL is executing as promised on its massive share buyback.  The company still has $27 in net cash on its balance sheet and free cash flow is high, sustaining balance sheet cash even as billions of dollars are spent on share buybacks and dividends each quarter.

AAPL is 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’s regulatory filings can be found at www.sec.gov.  AAPL is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.