Apple reported a strong 1Q20 and guided the current quarter nicely ahead of estimates on all key financial metrics.  This is clearly a positive for Apple shares.  However, the stock has soared recently, up 21% since Thanksgiving.  Northlake sees the latest good news as largely reflected in the current price of Apple shares.  Fundamentals are good and after a stretch of subdued growth Apple should have a couple good years ahead thanks to the upcoming 5G cycle in iPhones and continued growth in wearables and services.  We are comfortable continuing to own Apple shares but we see the risk-reward tradeoff as balanced.  Northlake emphasizes company fundamentals over any other factor impacting stock prices, so despite what we see as limited upside for Apple in the near-term we plan to sit tight with current client positions.  It is possible that some overweighted client positions could be cut back modestly.  We do want to note that we made similar comments after Apple’s earnings report in October.  The shares are now about 23X times 2020 earnings estimates nearly 59% above the average multiple the shares have traded at in the past 5 to 10 years.

The positive surprise in the December quarter mostly came from iPhones with revenue growth of 8% the best since the September quarter of 2018.  Analysts had expected a flat quarter for iPhones.  Clearly indications and reports that the iPhone 11 family was selling well turned out accurate.  Strength was primarily in the U.S. and Europe. China returned to growth for the first time in 18 months.  Wearables grew 37% led by AirPods.  Services grew 17%, perhaps a little short of steep estimates but a still healthy growth rate.  In services, management called out iCloud, Apple Music, Apple Pay, and advertising.

Combined Services and Wearables are up to 28% of trailing twelve months revenues.  This has significant implications for the other major positive in Apple’s latest report.  Gross margins surprised to the upside and moved to the top end of the tight range they have been in for several years.  Services has a higher gross margin of 64% vs. Products (phones and wearables) at 34%.  We believe that Wearables have an above average gross margin compared to the larger family of products that includes Phones, Macs, and iPads.  Management noted that iPhone gross margins improved due to lower input prices.  Guidance for upcoming gross margins suggest a new higher gross margin level could be sustainable.

The bull case for Apple that has driven the shares up since the middle of 2019 is that (1) the upcoming 5G wireless cycle will improve iPhone demand, (2) Services and Wearables are becoming large enough to drive overall company revenue growth, and (2) gross margins benefit from increased Services and Wearables revenue as a percent of overall revenue.  The 1Q20 report and 2Q20 guidance support this thesis.  As long as Apple is tracking to this investment thesis we see it as a core holding for Northlake clients.

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.