Shares of Apple (AAPL) have been fading lower following the release of its record quarter results. While the numbers themselves were worthy of a rally -- even in the face of macro headwinds -- the conservative guidance ultimately sent Apple stock retreating. Supply chain issues are still weighing on many firms.
Despite CEO Tim Cook's knack for dodging and weaving through the worst of supply chain woes, Apple is known to err on the side of caution. It's far better to set the bar low, with an increased chance of soaring over the mark, than running the risk of a surprising flop, even if it means overshadowing a record quarter.
Indeed, guidance is all investors seem to care about these days, but who can blame them, with all the recession chatter we've been hearing? I'm bullish on Apple.
Great Quarter; Overly Conservative Outlook?Looking to the numbers themselves, it was the Mac that had an opportunity to flex its muscles, thanks in part to the release of its powerful new M1, M1 Pro, and M1 Max lines of chips. Services really shined, with 17% in growth.
Moving ahead, services could continue to propel Apple's gross margins much higher. Morgan Stanley analyst Katy Huberty sees Apple keeping its gross margins well above 42% due to supply chain improvements, among other operational improvements.
I think she's right on the money. A continued services push could also propel margins to incredibly attractive new highs.
Currently, the Apple One bundle is an intriguing value for users. Apple TV+, its video-streaming service, got off to a slow start, but it's really picking up pace, with an Oscar win for best picture now in the bag.
For 2022, Apple could get even more attention from the mainstream media once it's time to roll out the red carpet again.
Apple Services GrowthHit shows like Severance and Pachinko have received incredibly high ratings according to RottenTomatoes and IMDb. Indeed, such shows are finding a spot with fans.
As more viewers get drawn in, it will be hard to hit the cancel button on that Apple TV+ service. With a quality-focused approach, it seems like Apple is doing a lot of things right, and it could evolve to become a top-three streamer one day.
Other services, including iCloud and Apple News, have also proven sticky as a part of the Apple One bundle.
It's Apple's gaming subscription service that I think may have its long-term potential discounted. Apple Arcade is a rather perplexing service at first glance. It seems to cannibalize App Store game sales, and it hasn't really made a big dent, despite being around for a few years now.
The real question investors should ask is what the gaming service sees itself becoming five to 10 years down the road.
While there are many ad-free mobile games available with the Apple Arcade subscription, it just hasn't garnered as much attention as the likes of a Microsoft (MSFT) Xbox Game Pass.
Apple is sticking within its circle of competence with Apple Arcade for now. By doing so, does it risk closing the door on the broader video-gaming market?
Apple and Game-Streaming?Mobile games are the fastest-growing segment. Still, Apple could use the service to push into cloud gaming, as some of its FAANG peers have already done.
In cloud gaming, Apple would clash with Microsoft, Alphabet (GOOGL), Amazon (AMZN), and even Nvidia (NVDA). Each firm has a game-streaming platform. Still, Microsoft is the only firm thus far that has the extensive content library to make its service a success.
Apple would need to go the exclusive route as it has with Apple TV+ before it would make sense to expand Apple Arcade to encompass triple-A titles.
The real reason Apple may have shied away from markets where its rivals have swooped into is that it believes that on-device gaming trumps cloud gaming. Undoubtedly, the M1 Ultra chip can game like Nvidia's best GPUs, and the mobile A15 is capable of powering so much more.
Still, the A15 may not be ready for the types of games that the cloud can handle. Given Apple's incredible low-power chips, I would not be surprised if Apple delivers a mobile chip capable of running heavy-duty console-grade gaming experiences on mobile, while using low power to do so.
A future iteration of the A-series chip, or the inclusion of an M-series chip in an iPhone, could allow for incredible gaming experiences without the need to be connected to a high-bandwidth, low-latency network.
Given Apple's chip prowess, I think Apple will steer clear of cloud gaming for now.
Eventually, the hardware will catch up, and Apple Arcade could evolve into something more like a Microsoft Game Pass.
Wall Street's TakeAccording to TipRanks, AAPL stock comes in as a Strong Buy. Out of 26 analyst ratings, there are 21 Buy recommendations and five Hold recommendations.
The average Apple price target is $191.04, implying 20.9% upside potential. Analyst price targets range from a low of $161 per share to a high of $215 per share.
Bottom Line on Apple StockFor now, Apple Arcade is an intriguing value for mobile gamers. It's a decent addition to the services bundle, but is not a game-changer (pardon the pun).
However, in five years, count me as unsurprised if more PC-quality triple-A games are included in the Apple Arcade service.
Currently, NBA 2K22 is the closest to a console-quality game on Apple Arcade.
Whether or not it's just the first of many types of games to land on the service remains to be seen.
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Tech shares have taken a beating in 2022 as higher interest rates decreased the present value of future earnings growth. Investors are thinking twice before paying above-market multiples, and are focusing on value stocks instead.
However a somewhat overlooked fact is that technology companies often have a very conservative capital structure. Most big technology companies, such as Apple (AAPL), are sitting on a net cash position. This is in contrast to utility and real estate companies, which often use leverage to juice up returns.
Avenues to Deploy Excess CapitalThere are several different ways companies can deploy this excess cash. First, they can invest it in their core businesses and grow organically. Second, they can use it for acquisitions. Third, they can return it to shareholders via dividends and buybacks. Lastly, they can keep their options open, and keep the dry powder on their books.
The last option allows companies to exploit periods of market turmoil to boost returns. This is what Warren Buffet does at Berkshire Hathaway (BRK.B). Berkshire ended Q1 2022 with around $103 billion in cash, down from $144 billion at the end of Q4 2021. In essence, Berkshire deemed the opportunities in Q1 2022 worth deploying some 28% of its cash pile.
It is likely that dropping share prices will prompt corporate treasurers to deploy the excess cash reserves accumulated in the good days. Nevertheless, as we have seen at Berkshire, some of the cash will remain on the books.
In this article I will explore what effects rising rates will have on corporate profits for some of the tech companies sitting on the largest cash pile.
AppleAt the end of Q1 2022 -- which for Apple is Q2 given the September financial year -- the interest-sensitive portions of Apple's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$28.1Marketable securities$164.6Commercial Paper$7Term debt$113Total$192.7$120Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureIn total, Apple is sitting on a net cash position of about $72.7 billion, which could fetch an extra $2 billion a year in pre-tax profits if reinvested at the 3% Fed funds rate currently expected by the market over the medium term.
The impact from the extra income largely depends on Apple's product cycle. I think the effect will be more noticeable in years without major product releases. Overall though the impact should be a boost to earnings by 2-3%.
Alphabet (GOOGL)At the end of Q1 2022, the interest-sensitive portions of Google's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$20.9Marketable securities$113Long-term debt$14.8Total$133.9$14.8Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureOverall, Google has at its disposal some $119.1 billion net for reinvestments, which could boost pre-tax income by some $3.3 billion over the medium term. Given the more conservative balance sheet of Google as compared to Apple, the boost to earnings should be around 4%.
Meta Platforms (FB)At the end of Q1 2022, the interest-sensitive portions of Facebook's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$14.9Marketable securities$29Total$43.9Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureCuriously, Facebook has no debts. As the company moves into a more mature phase, this may prompt the corporate treasurer to diversify the capital structure.
This should allow debt investors to have an allocation towards Facebook, and at the same time potentially lower the cost of capital.
As things stand, the net cash position of around $43.9 billion should bring an extra $1.2 billion in pre-tax income over the medium term. The overall boost to pre-tax income should be around 3%.
Amazon (AMZN)At the end of Q1 2022, the interest-sensitive portions of Amazon's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$36.4Marketable securities$30Long-term debt$47.5Total$66.4$47.5Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureAmazon recorded a sharp drop in marketable securities in Q1 2022 to $30 billion, down from $59.8 billion in Q4 2021. This was partly the result of a $8.2 billion valuation loss, of which $7.6 billion was due to a writedown in the value of Rivian (RIVN).
As of the end of Q1 2022, Amazon held a circa 18% stake in the electric car maker. Overall, the benefit to pre-tax profit from the reinvestment of the spare cash would be in the 1%-2% range.
Microsoft (MSFT)At the end of Q1 2022 -- which for Microsoft is Q3 given the June financial year -- the interest-sensitive portions of Microsoft's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$12.5Short-term investments$92.2Long-term debt$50Total$104.7$50Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureThe reinvestment of the net cash position of Microsoft at circa $54.7 billion would results in a pre-tax earnings boots of close to 2%.
Intel (INTC)At the end of Q1 2022, the interest-sensitive portions of Intel's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$6.2Short-term investments$32.5Debt$37.25Total$38.7$37.25Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureDespite boasting a large absolute cash pile, Intel's actual net cash position is negligible when the debt is taken into account.
Tesla (TSLA)At the end of Q1 2022, the interest-sensitive portions of Tesla's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$17.5Short-term investments$0.5Debt and finance leases$4.8Total$18$4.8Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureAutomakers have traditionally relied on having a sizable cash pile to ride out industry downturns. Tesla's $13.2-billion net cash position could boost pre-tax profits by $350 million, or 5%-6%, which is quite significant in percentage terms.
In absolute terms, however, given the market capitalization of the company, the effect would be negligible.
Nvidia (NVDA)At the end of January 2022, the interest-sensitive portions of Nvidia's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$2Short-term investments$19.2Long-term debt$10.9Total$21.2$10.9Selected Balance Sheet Items, Author's calculations based on January 2022 Annual reportNvidia boasts a net cash position of around $10.3 billion. A reinvestment at the expected 3% Fed funds rate could boost pre-tax returns by $275 million, or close to 3%.
SummaryWhen it comes to the cash pile of tech companies, the devil is in the details. Overall, the group will be a net beneficiary of higher rates.
Older tech companies, such as Intel, Microsoft, and Apple, have a more diversified capital structure, and a sizable debt component.
Over the short term, Tesla looks like the biggest winner of higher rates. However, this is the result of a small pre-tax profit relative to the net cash position.
I expect the effect to diminish as car production increases in the future, boosting pre-tax profits. Over the medium term, Google parent Alphabet should be the biggest beneficiary of higher rates, given its meaningful $119.1 billion net cash and cash equivalents position.
All in all, while higher rates will by no means be a main driver for tech earnings, most names should experience an earnings per share bump of several percentage points.
The effect may end up being slightly larger over the very short term. This is due to the fact that the debt companies have issued is usually with a fixed interest rate.
Eventually, these bonds will have to be refinanced at higher rates. In the meantime, however, their immediate cash reserves can be redeployed very quickly at the higher Fed funds rate.
Of course, this is offset by the fact that companies themselves have invested a portion of their marketable securities into longer-duration instruments.
At the end of the day, there is still a silver lining for tech shares when higher rates are concerned.
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