Apple (AAPL) reported mostly inline results for its 3Q16 report.  Slight upside existed across most key financial and unit volume metrics.  Guidance for the current quarter ending 9/30/16 was similar.  Given recent sentiment surrounding AAPL, this was good enough to allow the shares to rebound in their initial response to the report, up 7-8%.  AAPL remains down -1% YTD, still lagging the market’s gains.

The rally in the shares reflects stabilization in the company’s fundamentals.  This suggests that the bear case built on declining iPhone sales ultimately leading to collapsing profitability is less likely.  However, it is worth noting that revenues were -15%, EPS were -23%, gross margins fell almost 200 basis points, and operating margins declined from 28.4% to 23.9%.  iPhone unit sales fell -15%, and due to lower average selling prices as a result of the new iPhone SE, iPhone revenues were -23%.  Macs and iPads also saw declines in unit volumes and revenues, although iPads surprised to the upside on units and average selling prices as the new Pro model seems to be gaining traction.

We mention this negative growth because for AAPL shares to extend today’s rally significantly requires a return to growth.  We believe that will happen, possibly as soon as the December quarter but almost certainly in CY2017 when a bigger upgrade to the iPhone is coming and the high margin services businesses (App Store, Apple Music, Apple Pay, licensing, and possibly AppleTV) becomes a larger part of the overall business (we expect services to represents more than 12% of FY2017 revenue).

We are willing to wait for growth to return because AAPL shares remain very inexpensive, especially when adjusted for the company’s incredible financial strength.  AAPL trades at just 11.7X 2017 consensus EPS estimates, a significant discount to its peers and the broader market.  Giving credit for net cash, the multiple is less than 9X.  The company is about 75% of the way through a $250B capital allocation plan, returning cash to shareholders through dividends and share repurchases.  Even though most of the cash is overseas and would be taxed upon repatriation, the aggressive return of cash to shareholders suggests credit should be given  for the $27 per share in cash.  AAPL may no longer have massive upside but we see a path for better than market performance over the next 12-18 months.  Northlake clients should be aware that we may look to trim over weighted AAPL positions but this should not be viewed as a sign we are bearish on AAPL overall.

We hope and expect that the worst has passed for AAPL shares and better performance lies ahead.  The next big data point will be the reception to the iPhone launch in late September or early October.

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.