Apple (AAPL) is highly praised for beating earnings last night, I think the current spike in price doesn’t last
By now you’ve already read the fantastic earnings number, and I’m not taking anything away from that achievement. Please think about this. AAPL was for years trading at a multiple that hardware companies get, around 14 times. It‘s now trading at almost 25 times, the multiple of a consumer services company. For the last few years, Tim Cook along with willing stock analysts have been driving home the notion that AAPL has changed its stripes. Look at how strong our services revenue is growing, they said.
Naturally, once accepted the logic that AAPL deserves a higher multiple drove the stock price and the market cap ever higher. Analysts obliged the rise will mean higher price targets and as the price rose they lifted their targets. This pro-cyclical process must at some point come to a halt, even if temporarily. Right now Wedbush analyst Dan Ives, who I respect tremendously, has called for AAPL to reach a $2 trillion capitalization by 2021. Currently, AAPL is reaching $1.4 trillion in capitalization. Look, maybe AAPL does get to $2 trillion by the end of next year, maybe not. However, I think AAPL needs to consolidate the gains it already made and have a meaningful vacillation between these two valuation levels, lower for the hardware category and higher for the consumer category.
There’s no denying these are great results. AAPL profits up 11% to 22.2B, revenue is up 9% to $91.82B, sales of iPhones, which account for more than half of its revenue, rose 8% to $55.96 billion, all good. Wearables garnered a 37% surge, which also includes smartwatches and iPods. Services broke to new highs but missed estimates by $300 million to $12.7B, and to me, this is the big tell. Apple’s share price has more than doubled from last year’s low, adding more than $725 billion to its value, If we need to value the company on the services, services cannot underperform on expectations.
Apple executives said they expect the robust sales growth to continue in the current quarter, though they acknowledged the coronavirus outbreak had introduced some uncertainty in China, its second-most-important market and the country where most of its products are manufactured. I think this concern also weighs on the company.
Long story short – AAPL needs to contend with its valuation standards
AAPL beat on hardware. Missed on services and in-line with wearables, the result was well received was trading above 327 last night in post-market trading. Now in early morning trading I am seeing 324ish. I know the counter argument is that you have to grow iPhone sales to grow services. I would say obviously it helps the bull case, but that notion is patently untrue. AAPL should grow services to expected levels if it had services that everyone wants. I think AAPL gives up all its gains over the next day or two and help roll over the entire market.
We are seeing other hardware-related names trading down
AMD trading down 4% in the pre market. Q4 results that beat revenue estimates. The downside Q1 outlook sees revenue of about $1.8B, plus or minus $50M, and gross margin of about 46%. Computing and Graphics were up 30% Q/Q and 69% Y/Y to $1.66B vs. the $1.5B consensus. How many times do we hear tech companies pull in forward guidance? I suspect the pullback is related to China issues, but for now AMD that performed so fantastically is consolidating its gains. I see this as a trading opportunity in the next week or so. Xilinx (XLNX) really disappointed, and that should not be surprising since it’s an industrial chip name and global manufacturing has been in a bit of a slump. Still, the hardware sector is pulling back, I’m seeing Applied Materials (AMAT) and Micron (MU) trading in the red this morning too. I again say that AAPL should pull back and pressure the tech sector. We still have Amazon (AMZN) to report and if the recent past performance is any indicator AMZN should lag as well, helping to pull the indexes lower.
I don’t think we are fully done with the Wuhan Fever epidemic fallout either.
Starbucks (SBUX) closed its stores, Toyota (NYSE:TM) closed its plants, British Airways canceled all its flights, the first airline to do so. I see others following. Right now the latest numbers are 132 people dead, infected more than 6,000. If you believe Scott Gotlieb (I do), the former head of the FDA, you are highly suspicious of these numbers. He said China is underestimating the number of infected by the 10s of thousands. I have heard US estimates close to 10 times higher than the published numbers. I’m going with the idea that they are at least being truthful on the mortality ratio which is looking like it is dropping from initially 3%, then 2.5% and now about 2.2%. The falling mortality rate makes sense since the initially stricken voluntarily are likely the most ill, and likely have higher morbidity. Just to keep things in perspective, SARS had a 10% mortality rate for comparison. China is the world’s manufacturer, and US manufacturing relies on components and intermediate materials from China as well. All I’m saying is that there needs to be a full accounting of that effect on top of everything else. The market is vulnerable to one more “Wuhan Fever” shock, like someone contracting the fever outside of the hot zone, or China comes clean and tells the truth about how many infected and dead there really are.
Volatility is still here
VIX is still quite elevated and is likely to stay that way. I have been telling you to keep an eye on it. I have news for you, volatility is here and it’s going to overstay its welcome like your in-law’s coming to town. As I hope I’ve made abundantly clear this morning, I believe that we are still in a corrective phase. This petit rally is an interstitial one that will suck in a bunch of traders and hurt them as the indexes explore the lower trading range of this rally’s uptrend. Yes, I’m still a bull, but the oft-repeated truism holds true: “Trees don’t grow to the sky, and neither do stocks.” I’m standing by my 5% to 7% decline in the S&P 500 and then we get back toward previous levels. We must consolidate gains and chop around a bit before we reach for new highs later this year.
Let’s look at some positive things, like consumer confidence
Consumer confidence among American households rebounded in January. The increase was driven primarily by positive assessments of the labor market and increased optimism about future job prospects. Concerns about the spread of a new coronavirus in China and beyond have raised concerns about the global economy, but that was not reflected in the survey through Jan. 15. In this case, I don’t think Wuhan Fever will show up in consumer confidence numbers for the US unless we have evidence of a person-to-person infection here.
Sorrento Therapeutics got private equity takeover offer
Sorrento Therapeutics (SRNE) has rejected a second takeover offer from an unidentified private equity fund. News of the original bid sparked a surge in Sorrento’s sagging stock price, but the board has ruled the offer undervalues the biotech. Says Sorrento management: “The latest non-binding proposal received on Jan. 9, 2020, from a private equity fund to acquire a majority or all of the issued and outstanding shares of the company for “up to $7.00” per share significantly undervalues the company and is not in the best interest of the shareholders.” SRNE is currently trading at $4.
My Take: A private equity group apparently thought Sorrento was worth significantly more than the current level. Maybe we should take the PE view and buy SRNE. Maybe they raise the bid, or maybe market participants will be convinced to bid SRNE higher too.
CenturyLink (CTL) my stealth 5G play has a game in plain-old telecom too
CTL wins another government contract. Coming on the heels of last week’s $1.6 billion contract with the U.S. Department of Interior, the telco announced it has won a task order to provide secure connectivity to the U.S. Department of Defense Education Activity’s learning network.
CenturyLink also is adding 4,500 to 5,000 on-net fiber buildings each quarter, and currently has 150,000 buildings on-net. By contrast, Level 3 (acquired by CTL) used to add around 500 fiber buildings per quarter. CenturyLink’s near-term goal was for on-net fiber buildings is “north of 200,000.”
I like CTL as a long-term investment. It recently refinanced debt, and with these contracts, I think the dividend is safe, it pays nearly 7%. I call it my stealth 5G play because with 5G there will be an explosion of data traffic. That traffic will find its way on CTL fiber-optic networks.
Yet both these names are up strongly this morning in the pre market. I think for GE, the cash flow and revenue growth have beaten back the bears. I’m sticking to my price target for GE in 2020 is 14, and we will see the price getting close to 20 in 2021. I think that part of the positive reaction to BA’s earnings report is how GE assessed its position in jet engines. I have one quibble with analysts and I hope Larry Culp reconsiders if it’s true, that GE is looking to sell the rest of its healthcare division. I think this is a big mistake, and counter to what I think Culp brings to GE. Culp built up Danaher’s (DHR) healthcare division to an enviable level, and I think there’s a lot of undervalued names in the health tech, devices, and diagnostics space. I may even reassess my investment if this turns out to be correct. Culp has to show that he can build on what GE has, and use operational efficiencies and FCF to pay down debt, not sell parts to do so.
As for BA, it’s clear that Calhoun, the new CEO, has “kitchen sinked” the report. I think it is very telling that the losses included the charge for starting Max production back up in 2020. BA has to move 400 MAX jets to their owners over the next six months or more. What this CEO is telling us is that he fully expects manufacturing to restart in earnest before that process is completed. The CEO is on CNBC saying that the 737 MAX is now the safest plane on the market today. He refuses to change the name. “I am not going to market my way out of this” we will prove it to the pilots, and the flying public will follow” (this is a paraphrase as I understood the statement). I think BA easily rises to 350 in the next week or two and then on to 370 in a month.
My take: DFS has sold off hard on earnings just prior to these purchases. I think the number of senior executives including the CFO and CEO and the amount tells me that DFS should be considered if you are looking for alternatives to Visa (V) and Mastercard (MA).
My Trades: I am still long BA in CALLS, and will stay long even as I think that the indexes are going to come in. I own GE shares and will continue to accumulate it in my long-term investments. I believe that GE will once again become a good dividend payer and grower to justify it being a long-term investment. I’m a long term investor in CTL. I’m looking at SRNE as a speculation.
Disclosure: I am/we are long BA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long BA via Calls, I am long GE, and CTL via equities, and I am very intrigued by SRNE, and am considering a small position via equities.