Apple has a natural handicap in the battle to regain its crown as the world’s most valuable company. Semiconductor shortages bite hard for the technology group, which generated more than three quarters of its revenue from hardware sales during the third quarter. By contrast, Microsoft, the new stock market king, has been powered by a rapid rise in cloud computing, which accounted for almost 40 per cent of its revenue.
Apple’s slip was predictable after it missed analysts’ revenue forecasts in the fourth quarter of its financial year. Covid-related manufacturing disruption in east Asia and chip shortages hit sales of the iPhone, iPad and Mac harder than Tim Cook, the chief executive, had expected.
Cook has given plenty for Apple bears to chew on. Pandemic disruption has eased, but chip shortages have not and product inventory is below the target range. So the $6 billion that was wiped from revenue over the third quarter should be higher during the final three months of the year. Christmas is peak Apple selling season, after all.
Third-quarter revenue growth of 29 per cent and a 63 per cent rise in profits doesn’t cut it when expectations are so high. Even after last week’s minor slip, Apple has an enterprise value of just over 19 times forecast earnings before tax and other charges next year, a valuation gilded by ultra-low interest rates and a drive towards growth stocks.
Yet there’s also plenty to prop-up investor zeal. Cook has cited “double-digit upgrades and switchers” for the iPhone during the past quarter. Users of iPhones typically upgrade their handsets every three to four years. Wedbush, the investment bank, estimates that 250 million of the 975 million iPhone owners have not upgraded in about three and a half years and that 97 per cent of overall users stick with the iPhone — pent-up demand that bodes well for longer-term sales. The rollout of 5G could be another catalyst for users to upgrade, since most will require a new phone.
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One of Apple’s strengths is its higher-margin services business. More predictable, subscription-based revenue is highly prized by investors. Paid subscriptions stood at 745 million by the end of September, up 160 million since last year. Digital subscriptions and in app-purchases made via the App Store, upon which Apple earns a 30 per cent commission, together with services such as Apple TV helped to push services revenue to a record $18.3 billion in the third quarter and a profit margin of 70.5 per cent.
The power Apple wields is plain to see in the impact that its software privacy changes have had on fellow technology companies. Its move to prevent digital advertisers from tracking its customers without their consent was a blow to Snap, Twitter and Meta (formerly known as Facebook), social media players that generate sales via digital advertising.
Apple remains exposed to continued antitrust regulatory scrutiny. It has won a court battle with Epic, creator of the Fortnite video game, keeping app store payment terms in place. A concession allowing developers to offer app users alternative ways to pay the makers directly, outside of the Apple platform, is small beans to the group. However, another investigation by the European Commission relating to the app store is continuing.
Breaking through market value barriers makes for excellent headlines and Apple is reaching for $3 trillion. However, rising inflation and a likely increase in interest rates by the US Federal Reserve might make that a bumpy ride.
ADVICE Hold
WHY Sales potential looks priced in, given a potential shift from growth stocks and risk of further supply chain disruption in the short term
Trainline
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Just what investors don’t like to hear: “We’ve got less money coming in and more will be going out the door.” Unsurprisingly, that wasn’t the wording chosen by Trainline to detail plans to increase investment in its European business from later this year, but a further fall in the share price suggests that’s how shareholders read it.
The online travel ticketing group plans to spend more on hiring about 150 new staff and boosting marketing in several European countries, starting at the end of this year and into next and beyond. Numis cut its forecast for earnings before tax and other charges for 2023 by around £8 million to £79 million.
You can see why Trainline is looking to the Continent for revenue growth. After all, investors also detest uncertainty and the establishment of an online central ticketing system by the government’s new Great British Railways threatens to drive a train through the heart of the FTSE 250 group’s business model. The exact details of the booking system are thin on the ground, so management is adopting a “wait and see” approach.
Recovery in ticket sales, upon which Trainline takes a 5 per cent commission, also has been slow. Over the first six months of the year, net ticket sales in the core UK market were still just over half the pre-pandemic level as a steep decline in business travel has dragged on a consumer recovery. Analysts expect another pre-tax loss this year, of £22.5 million, although that would be down from £107 million last year.
High operating expenses associated with running the online platform, as well as marketing costs, mean the business has a history of losses long before the pandemic. Trainline secured a covenant waiver for the last financial year and a minimum liquidity requirement of £75 million has been put in place until the end of February next year, which the group satisfies. It also expects to meet an adjusted earnings covenant test that is due to be reintroduced in August.
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Investors are clearly reserving judgment — the shares, at just below 300p, are still priced a way below the pre-pandemic level. You can’t blame them.
ADVICE Avoid
WHY Uncertainty over recovery in business travel and competition from GBR
