When Apple (AAPL) reported its June quarter results, management hinted at supply chain issues beginning to impact the company’s ability to meet demand.  During the quarter, at a conference presentation, the company updated its guidance to note that about $3 billion in sales would be lost in the September quarter.  When the company reported September quarter earnings this week, the actual lost revenue amounted to $6 billion.  Guidance commentary indicated that at least another $6 billion in revenue would be lost in the December quarter.  Despite the sales shortfall that was primarily evident in iPhones, Apple still managed to match consensus estimates for EPS.

Stock Reaction:  After initially falling about 5% in response to the earnings, by the end of the next day’s trading Apple was only down about 2%.  The recovery makes sense to us as the details of the earnings report and management’s conference call commentary painted a clear picture of strong demand across the entire portfolio of products and services and execution on margins and cash flows remains best in class.

Earnings Analysis:  The supply chain issues have been in two buckets:  COVID related and semiconductor shortages.  Management noted that COVID issues had eased but low-tech semiconductors continue to be a problem.  Beyond supply chain, the results were quite good.  All products and services in all geographies grew well and management indicated that demand trends support more of the same.  We were especially impressed by 26% growth in services at a record gross margin.  Product gross margins held nicely despite pressures from the supply chain such as elevated freight.  Guidance calls for less than 10% revenue growth and a modest sequential decline in margins.  This is manageable in our view and we see only small changes in estimates that are not material to the long-term investment thesis.

Target Price:  The big questions for Apple investors are (1) how long will the supply chain issues last, and (2) are the lost sales deferred or destroyed.  Most observers see supply chain issues lasting until mid-2022 although Apple’s massive scale and importance to its suppliers should allow the company to be among the first to see better supplier deliveries.  There clearly will be some lost sales this quarter given that the holiday season brings gifts of Apple products.  We still expect the overwhelming majority of lost sales to be deferred.  Lost sales moving forward seem concentrated in iPhones.  Given already long upgrade cycles, we anticipate that most buyers will wait a few months for their new phone rather than permanently keep their current phone or switch away from Apple to Android.  Apple continues to have a high level of switchers in current sales supporting this outlook.  We also are encouraged by comments about demand which are consistent with the very strong reviews for all of Apple’s current generation product and services.  Macs and iPads especially seem to have taken a step forward while iPhones are benefitting from a backlog of phones 3-5 years old.  Services and wearables continue to grow rapidly off the flywheel of the ever-expanding installed base of iPhone users.

Despite our positive view of the company’s current performance and the likely recouping of most of the lost sales, we still see Apple shares as somewhat expensive and are sticking with our price target of $150.  At $150, the shares trade at 25 times 2022 expected earnings.  This is moderate but deserved premium to the S&P 500’s multiple of 20.
The shares currently are trading at $150 but we see no reason to sell or aggressively reduce positions given the overall quality of the company and at least several more years of solid growth. 

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.