Apple reported largely inline results for its 4Q16 ending September 30.  Guidance for 1Q16, encompassing the very large holiday quarter, also was close to Wall Street expectations.  The shares are trading off several percent this morning following last night’s report and conference call.  We see this mostly as a result of the 25% move higher off the June 2016 low as investors began to see 2016 as the bottom for Apple’s growth and a better than feared sales performance for iPhone 7 models.  Our takeaways from the quarter and guidance is that the next big move in Apple shares, up or down, is likely several quarters out as the 10^th anniversary iPhone 8 comes into focus.  The shares remain inexpensive, particularly when considering the massive cash balance.  However, Apple is not growing at the moment.  Until it becomes clear that it will again have a period of sustained growth, the cheap valuation is not enough to drive the shares meaningfully higher.

A few things that stood out to us from Apple’s latest report and conference call:

• The company is becoming highly predictable. Under Tim Cook, guidance is more realistic and granular and variance from guidance in reported results is modest.  Consequently, the stock is less volatile around earnings reports.
• Investors anticipated a boost from a mix shift in favor the 7 Plus. This does not appear to be occurring as supply constraints limit the 7 Plus units for sale.  This is unfortunate due to Samsung’s problems and it is fair to criticize Apple’s usually excellent supply chain management.  Lack of 7 Plus units took away upside in revenue and especially profit margins.
• The service business (App Store, Music, Apple Pay) is starting to matter. Segment revenue grew 24%, ahead of estimates for 20% growth.  Services have grown from less than 9% of revenue to over 11% of revenue in the last five quarters.  At 20% plus growth, services drive over 2% growth before iPhones even are considered and this contribution is going to grow.  Furthermore, services are a very high margin business.  Services represent the long-term vision for Apple where the loyalty and network effect of its gigantic customer base drives steady growth with a wide competitive moat.  This is how Apple shares regain relative valuation and take the next big move up.
• China has decelerated rapidly and revenue fell sharply year over year for the second consecutive quarter. Management remains optimistic and predicts growth in the December quarter.  More focus continues to be placed on India, now a regular mention on conference calls.

Northlake is going to stick with Apple even aware that the next few quarters may see the shares stagnate.  Hopefully, December quarter guidance proves conservative.  Looking a little further ahead, April will be the next time the company updates its capital allocation policy.  Perhaps a larger than expected increase in the quarterly dividend and share buyback could be a positive catalyst.

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.