Stockwatch: Is this tech giant a Brexit hedge?

by Edmond Jackson from interactive investor |

In the wake of Apple results, are its shares a worthwhile Brexit hedge for sterling-based investors?

Can Apple (NASDAQ:AAPL) shares shrug off being so affected by the overall US market trend? In principle they look to be an attractive hedge for sterling-based investors, with the latest quarterly results affirming successful diversification from the iPhone which used to flag "one-product company" - at least in terms of growth momentum.

In practice Apple blips about with the US market even when declaring numbers and narrative that beat expectations. Thus a jump near $221 in reaction to Apple’s third quarter results (calendar second quarter) was checked to $213 - up 2% last Wednesday - once the timid 0.25% interest rate cut by the Federal Reserve fell short of expectations.

As hopes grew on Thursday of a second rate cut in September, Apple advanced with the market to $218 but similarly dropped to $209 after President Trump tweeted an extra tariff hike on China from September.

My point being, if US stocks are jittery like this, chiefly because the market has reached a high valuation is it rational to use them now as a hedge against a hard Brexit?

A trading chip on the major macro issues

The medium-term context saw Apple reach an all-time high of $228 a year ago, then plunge 35% by the end of 2019 as stocks took fright that the US Federal Reserve was in determined monetary tightening mode.

Then after a Fed official soothed fears on Christmas Eve, Apple began soaring from $148 with the rest of the market until May when Trump's administration banned US companies dealing with Huawei, although this eased in late June after the Chinese made it a criterion to be able to advance trade talks.

So although I've successfully drawn attention to Apple for a relatively modest PE versus other US tech-stocks, on the basis of a major refreshment of products underway - originally at $71 (adjusted for stock split) in August 2013, on 12.5 times earnings - I concede the last year has shown it more a trading chip on the major macro issues.

Holders therefore need to be confident that President Trump and Fed Governor Powell can between the two of them chart policy capably, or at least follow this intently.

US tech giants are at least maintaining big profits

It's a key upshot from the second (calendar) earnings quarter: Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL) and Amazon (NASDAQ:AMZN) sustaining growth rates of about 20% in core businesses such as social media, digital advertising and e-commerce; lending the US stock market something of a prop.

Apple is not rated anywhere near so highly - a PE multiple that's edged up to 18 times historic earnings - though admittedly group financials have yet to shine while a mature smartphone market offsets growth in new products and services.

Yet the stock rose because numbers either showed growth after a last two declining quarters, or beat expectations.

Thus group revenue edged up 1% to $53.81 billion (£44.44 billion) despite currency headwinds, while profit fell for a third consecutive quarter, by 13% to $10.04 billion although EPS of $2.18 beat consensus.

Products revenue eased 2% year-on-year which "improved" on an 8% decline in Apple's first-half year, though outside the iPhone it grew 20% boosted by wearables, Mac and iPad - the two relatively traditional products showing growth quite like Microsoft continues to capitalise on its Surface laptops.

iPhone revenues are down 12% to $25.99 billion as smartphone sales mature and the space gets ever-more competitive and "upgrades" struggle to take the telephony/web-browsing/camera package seriously higher.

Apple's future, therefore, rests in capitalising on its users’ goodwill, part-achieved via the iPhone, for new legs of growth, where encouragingly services revenue has grown around 17% if adjusting for exceptional legal costs, despite a headline figure of 13%.

Significantly, group revenue is now guided at $61-64 billion for July to September, quite a range yet above expectations.

Gross margins are overall flat at 37.6%, slightly down in products to 30.4% while services rose to 64.1% helped by a favourable product mix. The table shows services rising from 19% to 21% of group revenue, year-on-year, and admittedly a way to go towards tilting the margin profile.

Apple Inc - category & geographic sales        
$ millions        
  Three months ended   Nine months ended  
  30-Jun-18 29-Jun-19 30-Jun-18 29-Jun-19
By category:        
iPhone 29,470 25,986 128,133 109,019
Mac 5,258 5,820 17,858 18,749
iPad 4,634 5,023 14,397 16,624
Wearables, home etc 3,733 5,525 13,158 17,962
Services 10,170 11,455 29,149 33,780
Total net sales: 53,265 53,809 202,695 196,134
By area:        
Americas 24,542 25,056 84,856 87,592
Europe 12,138 11,925 47,038 45,342
Greater China 9,551 9,157 40,531 32,544
Japan 3,867 4,082 16,572 16,524
Rest of Asia Pacific 3,167 3,589 13,978 14,132
Total net sales: 53,265 53,809 202,695 196,134

Source: Company REFS

China as a short to medium term risk variable

Note from the table a 19.7% decline in revenue from "Greater China" (China, Hong Kong and Taiwan) on a nine-months' view, though this eased to 4.1% in the latest quarter.

Given this region represents about a fifth of Apple's revenue and has been seen as a future plank for growth, it's an obvious concern while President Trump keeps turning the trade tariffs screw.

Apple is in a dilemma of having to cut prices versus domestic competition that's evolved superior to iPhones in various aspects of performance, and is also viewed as the patriotic choice while US/China trade frictions drag on.

Android also generally offers more by way of smartphone apps and features.

So the case for buying Apple has become more a case whether you prefer being part of the Apple operating system, e.g. for convenience as users of the Mac or iPad.

The Chinese market brings this into sharp focus as a model for how consumer choice could evolve, also taking price into account.

At least the Trump administration has partially lifted May's ban on US firms doing business with Huawei, but I suspect his latest raft of tariffs now exposes Apple – among US stocks sensitive to the China trade story.

For this reason I'd hold off any fresh buying until it's better seen how Trump's "re-set" of the US-Chinese relationship proves, which doesn't coincide well as a Brexit/sterling equity hedge.

Regulatory and staff turnover are other issues

Compared with other US tech giants, Apple has faced relatively few challenges e.g. by Congressmen; though it has attracted lawsuits e.g. by customers and developers over its App Store which is a monopolist distributor for over 900 million iPhones globally.

This explains the latest exceptional cost within Services. Rivals say it's hard to market themselves in the App Store, and I would add that if Apple proves stubborn then competitively it will underline Android as offering more choice.

The issue needs watching given the App Store constitutes about a third of Services' sales.
There has also been some key staff turnover in recent months e.g. the head of retail departing, also the chief design officer to form his own company, and several members of the industrial design team.

That’s a concern given high-quality tech demands the best people and perceived working environment.

Yet the cash profile remains high-quality

Apple ended June with nearly $211 billion versus total debt of $108 billion and it remains committed to becoming cash neutral over time. About $17 billion was spent during the quarter on buybacks and $3.6 billion on actual dividend returns.

Cash generation remains strong at $11.6 billion during the quarter, 16% ahead of net income which affirms a quality business. Obviously all this didn’t prevent a 35% plunge in the stock in late 2019 and a circa 1.5% prospective yield is no prop.

So I conclude with Apple being a prime example of risk/reward in the US stocks currently: sensitive to the China trade issue but overall in good health with big tech’s innovations being a pillar for the market.

I reiterate my stance to buy its drops as I believe that quite as Microsoft navigated new challenges, Apple enjoys a critical mass of goodwill among its customers and talent within — despite the resignations, and CEO Tim Cook maybe not as impressive as Satya Nadella at Microsoft (NASDAQ:MSFT).

With fresh money it could be premature to act now, e.g. for a Brexit/sterling hedge. Wait and see if Trump's tactic works out, to bring China to a deal, lest the stock trends lower before September. That could coincide nicely with how Brexit events unfold in the UK parliament, for buyers. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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