Apple reported a mostly inline March quarter and issued guidance for June quarter that was within its usual range.  Revenues for the March quarter fell slightly short of estimates driven by iPhone unit shipments of 50.8 million compared to consensus of 52.3 million.  That equates to about $1 billion in lost revenue relative to expectations.  Overall revenue was just $104 million light with the difference being made by better than expected results from iPad, Other products (Watch, Beats, AirPods), and Macs.  EPS ended up a little ahead of consensus at $2.10 vs. $2.02.  The upside came from better margins as Apple managed gross margins well despite headwinds form higher memory prices and foreign exchange.

Guidance for revenues in the June quarter fell about $1 billion short at the midpoint.  The midpoint of gross margin guidance is 37.9% vs. street expectations of 38.3%.  We find the gross margin guidance impressive despite the small shortfall given continued elevated memory prices and deleverage from the seasonally small revenues in the June quarter.

Apple also updated its capital allocation program.  The total program was extend one year into 2019 and increased by $50 billion to $300 billion.  Share buybacks will consume most of the incremental $50 billion but the dividend was also raised by 10.5%.  Management pointed out that the increase in capital return to shareholders is based on current U.S. tax law.  They went further to state that should tax law change they would reassess.  Apple would be a major beneficiary if repatriation of foreign cash at a very low tax rate is ever put into law.  A very significant of portion of Apple’s $256 billion in cash is held abroad.  Net cash after debt is $162 billion or almost $31 per share.

The reality is that all you just read is small potatoes as it concerns the next big move in Apple’s stock price.  Small fluctuations will take place.  We expect the stock to be down a few percent on the latest news since there was no upside and there is a lack of catalysts until the new iPhones are announced and hit stores next holiday season.  And it is the success of the next generation of iPhones that will determine if Apple is still viewed as a growth company or has finally matured into very profitable, but low-growth free cash flow machine.

Apple does have growth businesses in wearables and services.  Together these business lines are 21% of revenues.  These businesses are growing fast and can lift overall revenue growth by a few percent a year for the next several years.  Services (Apple Pay, Apple Music, App Store subscriptions) have high gross margins that can also support profitably.

But the next iPhone cycle is what really matters.  There is a huge installed base of 2-4 year old iPhones currently in use and the next phone is expected to be offered in at least one variation with a new hardware form.  Analysts believe this sets up a “super cycle” where iPhone units boom, like they did for iPhone 6 when larger screens were first offered.  The super cycle is critical not just for iPhone but also for sustaining the growth in services and wearables by continuing to grow the global network of iPhone users.

Northlake’s bottom line is that Apple is likely to a boring stock until we get close to the announcement of the new iPhones this fall.  Investor expectations are in check so as long as the launch of new phones is on track, there should not be much downside independent of overall market moves.  However, we also see little upside for a few months as the shares are fairly valued at a P-E of 14X 2018 estimated earnings.

We have some concerns regarding the super cycle thesis.  Will there be enough demand for a higher priced iPhone 8 or have phones reached the point where they do not need to be replaced often, much like PCs and tablets?  Will Apple actually ship an entirely new form factor this holiday season in volume or will we get more of the standard iPhone S upcycle and a new form factor with new features a little later?  We are willing to wait a few quarters to find out the answer as we lean firmly to good demand for the new phones and if that occurs, especially along with repatriation of foreign cash at a low tax rate, AAPL shares still have significant upside.

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.