There is no super cycle at Apple but business fundamentals at Apple still look solid.  Apple reported earnings in line with Wall Street estimates but ahead of fears.  Guidance for the next quarter was ahead of recently lowered investor expectations.  The key takeaways from Apple’s quarter are:

• iPhone units volumes are not collapsing, growing 3% year over year in the March quarter with implied guidance for flat sales in the June quarter.
• The iPhone X strategy is having important positive effects. It was the best-selling phone during the quarter, the first time since Apple split the iPhone line into a regular phone and plus phone that the high end phone was the best seller.  This drove ASPs up 11%, leading to a 14% revenue increase for iPhones.
• China revenues grew 21%, the highest growth rate in several years. The iPhone X did particularly well in China as despite overall weakness in the country’s smartphone market, the high end remains solid.
• Services and wearables grew very strongly, north of 30%. These business lines are up to 13% of total Apple revenues and getting large enough to help overall revenue growth and profit margins.
• Within Services, Apple claims to have 270 million paying subscribers, up 100 million year over year. Apple Music and iCloud are the bulk of these subscribers.  Subscribers offer predictable high margin revenue that Wall Street loves.  See Netflix, Amazon Prime, and Spotify.
• Recent pressure on gross margins should begin to ease as 2018 progresses. With the rising contribution of high margin services and wearables, 2019 could see positive operating leverage.  Several analysts pressed this point and while management would not confirm they did not push back very hard.
• Inventories of iPhones are in good shape, within their normal range of 5 to 7 weeks. This suggests sell though of phones in the March quarter was up mid single digits.  More importantly, it sets up the June quarter to have unit volumes north of 40 million, well ahead of recently lowered estimates centered around 39 million.
• Apple still believes smartphones are a growth market based on the fact that 500 million feature phones are still sold every year and eventually every phone sold will be a smartphone.
• The company raised the dividend by 16% and initiated an additional $100 billion buyback. We would prefer a larger dividend but approve overall of the capital allocation strategy.  We expect another large buyback announcement and dividend increase next year at this time.

Overall, we feel better about Apple than we have in several quarters.  Investor sentiment and expectations have cooled yet the business is still on solid footing.  2019 could set up well if the new phones announced this fall sell well; a fair assumption as the lack of a super cycle on the iPhone 8/X leaves a huge base of 2-4 year old phones that could be upgraded.  There is some evidence among the latest U.S. wireless carrier reports than upgrade rates could be bottoming.  Continued growth in high margin services and easing margin pressures as the iPhone X matures and component inflation eases could be evident by later this year.

Northlake still sees upside in Apple to around $200 based on 15X 2019 consensus earnings estimates.

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. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.