Apple Earning Preview – Too many Risks heading into Earnings

It’s going to be a down quarter for Apple Inc. (AAPL). Margins are falling, inventory is increasing, and sales are sliding. That’s normally a lethal combination. However, Google Trends suggest the smartphonemaker’s top and bottom lines could come in better than Wall Street’s consensus outlook.

Apple will release its 2019 third quarter earnings after the market close on July 29,2019. Analysts pegged a consensus of $2.10 per share in earning on $53.39 billion in sales. While year-over-year revenue is forecasted to inch up a measly 0.20%, earnings-per-share are anticipated to dip 10.3% from $2.34 a year ago.

Margins could be the story in tomorrow’s newspaper. Apple’s financial statements from the second quarter show rising costs and increased inventories levels eating away at the blue-chip tech company’s bottom line.

Combine higher costs and flat sales growth and you have the making of a problem .

Last quarter, AAPL’s cost of sales rose to 62.4% of revenue in 2019 versus 61.7% during the same time period in 2018. While that doesn’t sound too alarming, it’s a difference of $405 million. A few hundred million here, a few hundred million there…

Total operating expenses increased to 14.49% for the three months ending March 30, 2019 compared to 12.31% a year ago. If there is any silver lining, the bulk of the increase is in Research and Development (R&D). The line item rose to 8.48% of revenue from 6.59%, year-over-year. While R&D will likely pay off down the line, probably mid-to-late 2020 as the 5G cycle ramps up, it could dampen EPS between here and there.

Selling, General, and Administrative (SG&A) costs bumped mildly, rising to 7.68% of sales in 2019’s second quarter against 6.79% in 2018. Again, it looks like nothing, but it’s a $520 million variance .

Combined, cost of sales and SGA increased close to $1 billion .

Another hit to margins could come from inventory increasing to 8.42% of revenue in 2019’s second quarter compared to 6.93% in the first quarter. iHeads could be waiting on Apple’s 5G product line before upgrading. If that’s the case, the average selling price for the iPhone could dip as incentives are used to move products that are getting dusty on the shelf. Lower average selling prices could send Wall Street running from Apple until the next cycle begins .

iPhone sales are the major driver for Apple’s top and bottom lines, accounting for 54% of revenue in the second quarter. According to Google Trends, searches for the keyword “iPhone” are down 9.44% in the third quarter of 2019 compared to 2018 .

That might look bad on paper but could deliver better than expected revenue if iPhone’s share of the pizza pie remains at 54%. It would put sales north of $60 billion, smashing expectations. However, iPhone web queries shrunk by 6.13% in this year’s third quarter compared to the second quarter, setting revenue at $53.58 billion. That would be slightly better than the street’s consensus outlook.

Should net income stay at 19.93% or revenue, net income would tally $10.66721 billion, equaling earnings per share of $2.28. A bullish surprise of $0.18. Beating the street’s outlook is no big deal, as Apple has exceeded expectations the last 12 quarters .

Forward guidance will likely determine how investors react post announcement. Shares could be in peril as AAPL’s price is converging on two trendlines, lower highs and higher lows. Picture a triangle coming to a point. If traders cheer Apple’s results, then the stock price could run into the $220 range. On the flipside, if results stumble, then the 50-day moving average of $190ish could be the downside target .

The play: Apple’s earnings pose a risk for investors on multiple fronts; iPhone sales are stalling, margins are shrinking, inventory is climbing, and the stock price is at a decision point. Most of these concerns lean bearish. In our opinion, downside risks outweigh upside potential.