I/O Fund CEO and Lead Tech Analyst Beth Kindig joins Ash Bennington, Senior Host & Crypto Editor of Real Vision, to discuss the explosive growth and future potential of Nvidia, the latest semiconductor developments, and much more. Beth explains why she remains bullish on Nvidia but is not a buyer now, how her $10 trillion market cap prediction is progressing, and how Nvidia’s CUDA platform has created an “unbreachable” moat.
Nvidia’s product roadmap is very strong, and companies focussing on custom silicon chips are having a hard time keeping up, especially with the introduction of the new Blackwell systems. The company has created an additional layer of moat with the move to release AI chips to a yearly cadence, so it’s even impossible for the Big Tech companies to catch up with Nvidia right now.
We are not buying Nvidia right now because SMH is not supporting its all-time high, and we would like to see that resolved before we resume buying Nvidia. The PC rebound is also slower than expected, so SMH has not been able to keep up with the three AI stocks, namely Nvidia, TSMC, and Broadcom.
I/O Fund CEO and Lead Tech Analyst Beth Kindig joins Ash Bennington, Senior Host & Crypto Editor of Real Vision, to discuss the explosive growth and future potential of Nvidia, the latest semiconductor developments, and much more. Beth explains why she remains bullish on Nvidia but is not a buyer now, how her $10 trillion market cap prediction is progressing, and how Nvidia’s CUDA platform has created an “unbreachable” moat.
Nvidia’s product roadmap is very strong, and companies focussing on custom silicon chips are having a hard time keeping up, especially with the introduction of the new Blackwell systems. The company has created an additional layer of moat with the move to release AI chips to a yearly cadence, so it’s even impossible for the Big Tech companies to catch up with Nvidia right now.
We are not buying Nvidia right now because SMH is not supporting its all-time high, and we would like to see that resolved before we resume buying Nvidia. The PC rebound is also slower than expected, so SMH has not been able to keep up with the three AI stocks, namely Nvidia, TSMC, and Broadcom.
Lead Tech Analyst Beth Kindig had the pleasure of joining Darius Dale, CEO and co-founder of 42 Macro. Darius has a strong background in macroeconomics and specializes in a quantitative economic outlook and investment strategy.
In the interview, the two of them discuss the I/O Fund’s idea generation process, outlook for where we are in the tech cycle, why the I/O Fund is not buying Nvidia right now, and other active risk management strategies that help our firm to outperform the market.
You can watch the full 1-hour video interview here.
Current Tech Cycle
In the clip below, Beth explains why the I/O Fund is not buyers of stocks at the moment. She stated: “Over the next three to six months, we are not buyers […] of the stocks are reaching our price targets and [we are] waiting for the next sell-off to buy quality names at lower price levels. So, in terms of the tech cycle this is not a time that we are buying stocks.”
Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more here.
Rolling the Dice on Getting Nvidia Lower:
In the interview, Beth Kindig stated: “We ultimately think you can get Nvidia lower than where it is trading now. We are likely to take gains between $120 and $150 based on technical levels. The valuation has finally caught up to the fundamentals, and we have about six to nine months before Blackwell arrives.”
Earlier this year, Beth Kindig also spoke on Yahoo Finance that Blackwell Shipments are ‘not a concern’ to clear the noise that investors had about the delay in Blackwell chips. Also, we could expect fireworks in the first half of 2025 due to Blackwell. She also boldly wrote The Information was exaggerating the Blackwell delay, and recently stated Nvidia would reach a $10 trillion market cap following her prescient call years ago that Nvidia would surpass Apple’s valuation.
Despite Beth’s bullish stance, she stresses the importance of using technical analysis, as tech investing is sentiment-driven and has proven to have stellar returns in the past. I/O Fund has a history of buying Nvidia at low prices. The first entry was $3.15 in December 2018 and provided 9 buy alerts below $20 for Nvidia. The I/O Fund is preparing to repeat the process of buying low for the benefit of their Premium Members, who receive real-time trade alerts for every entry.
Nvidia is NOT Cisco: Why AI is Nothing Like Dot-Com
In this interview, Beth Kindig explains the key difference between the dot-com bubble period and the current AI opportunity. The internet is open source and democratized. Any person can easily put up a website and nobody owns the internet. On the other hand, AI is proprietary and the companies own their own models. The number of companies that can invest in training LLMs are very few, at this time. This fundamental difference suggests that a direct parallel between the dot-com bubble and the current AI boom is not applicable.
The company also highlighted earlier this year that the NVIDIA Omniverse Enterprise software subscription is $4,500 per GPU per year, which further highlights the point that Nvidia cannot be compared to Cisco.
Colette Kress, CFO of Nvidia, highlighted in the Q1 earnings call the return on investment for Cloud Service Providers by renting GPUs. “For every $1 spent on NVIDIA AI infrastructure, cloud providers have an opportunity to earn $5 in GPU instant hosting revenue over four years. NVIDIA's rich software stack and ecosystem and tight integration with cloud providers makes it easy for end customers up and running on NVIDIA GPU instances in the public cloud.” This sheds light on why capex budgets continue to grow.
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Beth Kindig has also discussed on X.com that even though shares rose more than 1,000% since 2022 lows, Nvidia’s forward P/E did not reach the heights of Cisco in 2022, suggesting that it’s not accurate to drawing parallels between the two:
Risk Management
Beth also says that diversification is not a good strategy for tech investors. Instead, the I/O Fund allocates 20% of our portfolio to a promising stock. She also points out that broad market performance is equally important for tech stocks to perform well and, finally, to adhere to stop-loss orders. The I/O Fund has cut positions on the stocks that we are long-term bullish in an attempt to buy at lower levels. She provides the example of how our firm has actively managed Microsoft in the interview.
While Wall Street is worried about how much AI is costing, the I/O Fund is busy calculating how big the AI opportunity can get in the next few years and how investors can participate. Learn more about the I/O Fund’s holdings, including when the firm plans to buy Nvidia next, plus consistent deep dive research on AI stocks, crypto and more here.here.
Disclaimer: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in NVDA at the time of the writing.
Netflix logged its largest EPS beat since Q3 2022 with phenomenal 83% YoY EPS growth, as it reported an acceleration in both revenue and global membership growth in Q1. This was driven by strong paid net adds of 9.33 million in the quarter, far above consensus estimates for 4.11 million net adds.
However, Netflix guided Q2 revenue slightly below consensus, though it still points to revenue acceleration continuing for at least one more quarter. In addition, the fiscal year revenue growth guide was a bit soft and hinted at a back half deceleration.
Netflix also announced a change in its reporting metrics. Starting next year in Q1 2025, Netflix will no longer report quarterly membership numbers and ARM, though it will continue to report revenue by region. In addition, Netflix will begin guiding full-year revenue numbers and provide updates on “major subscriber milestones” as they occur. The markets do not like changes like this, and it likely contributed to the weak price action. We detail what we think is the motivation behind these key metrics being dropped below in the Q&A section.
Revenue and EPS:
Revenue of $9.37 billion beat estimates by less than 1%, representing YoY growth of 14.8%. This was Netflix’s highest revenue growth since Q4 2021.
EPS increased more than 83% YoY to $5.28 versus consensus of $4.54, beating estimates by 16.8%. Netflix reported $2.332 billion in net income, more than 18% higher than mgmt’s guide for $1.976 billion.
For Q2, Netflix guided revenue of $9.49 billion, representing YoY growth of 15.9%. This was slightly below consensus of $9.53 billion for 16.3% YoY growth.
Netflix guided EPS of $4.68 in Q2, representing YoY growth of more than 42%.
For the full year, Netflix called for “healthy” revenue growth between 13% to 15%, versus analyst estimates for nearly 14.4% growth. This is construed as a miss at the midpoint. It also indicates a lower rate in H2 since Q1 and Q2 were growth rates of 15% to 16% growth.
Margins:
Netflix reported an operating margin of 28.1% in Q1, its highest ever as margins continue to expand across the board. Netflix boosted its full year operating margin guide by 100 bp to 25%, which would represent a solid 440 bp improvement from 20.6% in 2023.
Gross margin was 46.9%, a 580 bp YoY expansion as gross profit rose nearly 31% YoY.
Operating margin was 28.1%, a 710 bp YoY improvement as Netflix reported 54% growth in operating income. Timing of content spend and the higher-than-anticipated revenue also aided this operating margin expansion.
Net margin was 24.9%, a 900 bp YoY expansion due to the strong 79% YoY increase in net income.
Operating margin for Q2 was guided at 26.6%, a 410 bp YoY expansion though slightly 150 bp lower sequentially. For the full year, Netflix boosted its operating margin guide to 25% from a prior view for 24%, suggesting that while margins are strong in 1H, a deceleration in 2H to the low-20% range is likely.
Net margin for Q2 was 21.7%, a 610 bp YoY improvement, but again a 320 bp sequential decline.
Cash and Debt:
Operating cash flow in Q1 was $2.21 billion for a margin of 23.6%. This is Netflix’s second-highest quarterly OCF margin and only its third OCF margin to be above 20%.
Free cash flow was $2.14 billion for a margin of 22.8%. Similar to OCF, this was the second-highest quarterly FCF margin and the third above 20%. Despite the strong FCF number, Netflix maintained its $6 billion guide for the full year.
Cash and short-term investments totaled $7.04 billion, while gross debt totaled $14.0 billion, as Netflix paid down $0.4 billion in senior notes in the quarter.
Netflix reported a cash spend of $17 billion. Content spend is often asked about given the budget can be quite large for Netflix. Management stated: “So we believe we can manage to that roughly 1 to 1 of cash content spend relative to expense on the P&L.”
The company repurchased $2 billion shares this quarter.
Key Metrics:
Paid Net Adds Blow Past Consensus
Though we had noted in our pre-earnings report that management’s commentary pointed to a wide possible range for net adds (between 2M and 13M), Netflix reported paid net adds at the high end of that range at 9.33 million. This compared to just 4.11 million expected by some analysts, and some as high as 5.11 million from TD Cowen’s bullish view – essentially, Netflix blew it out of the water with paid net adds in the quarter.
This pushed global paid memberships up to nearly 270 million, or a YoY increase of 16%. This is the fastest growth in global paid memberships since Q4 2020 – Netflix is one of the few, if only, pandemic beneficiaries to return to pandemic growth rates. This also marks a sharp acceleration from less than 5% growth in Q1 last year.
Breaking down paid net adds geographically shows that the growth was well rounded. EMEA saw paid net adds of over 2.91 million, while UCAN added 2.53 million and APAC nearly 2.16 million. Here’s a snapshot of the regional highlights:
EMEA has reported >2 million paid net adds for four consecutive quarters. Paid net adds in the region totaled nearly 8 million in the past two quarters.
APAC has reported >2 million paid net adds for two consecutive quarters, and more than 5 million paid net adds in the past two quarters combined, for total membership growth of nearly 12% since Q3 2023.
UCAN’s 2.53 million paid net adds were more than 40% of 2023’s paid net adds for the entire year.
For Q2, Netflix guided paid net adds to be down sequentially, following seasonal trends. Given the wide range of possible outcomes again, this will be an important metric to track next quarter.
ARM: 1% YoY Increase
We had noted that ARM would be one of the more important metrics coming out of this report, on expectations for an inflection back to growth in 2024.
ARM increased 1% YoY in Q1, and 4% on an FX neutral basis, compared to 1% on a reported and FX neutral basis in Q4. Management expects ARM to increase YoY in Q2.
This growth in ARM was driven primarily by UCAN, which saw ARM increase 7% YoY to $17.30.
EMEA’s ARM was flat YoY, breaking four quarters of declines on an FX neutral basis.
LATAM continued to face headwinds from the major devaluation of the Argentine peso, reporting a (4%) YoY decline in Arm but a 16% increase on an FX neutral basis.
APAC provided the largest headwind to ARM, with a (8%) YoY decline or (4%) on an FX neutral basis.
Earnings Call
Cutting Off Password Sharing Will (at some point) Reach Saturation
One analyst is probed into how far along Netflix is into cutting password sharing off. Management did not give a straight forward answer but this is important to consider if management is wanting to phase-out key metrics that may have been bolstered by this. Typically dropping key metrics is a flag, so analysts were trying to figure out indirectly what the cause could be.
Our next question comes from Alan Gould of Loop Capital. Which inning are we in with respect to enforcing paid sharing? Two years ago, you said 100 million subscribers were sharing passwords with 30 million in UCAN. How many do you estimate still borrow passwords? And I'll turn the floor over to Greg to answer that question.
The answer was long but vague, and offered no transparency into the potential saturation of cutting-off PW sharing: “I think worth noting that while we're fully anticipating continuing to grow subs, the overall business growth now has extra levers and extra drivers like plan optimization, including things like extra members, ads revenue, pricing into more value, which is important. So those levers are also an increasingly important part of our growth model as well.”
Another analyst snuck this in and it was not refuted. It’s subtle that management didn’t state otherwise but important to note. “Could you please provide an update on engagement trends now that paid sharing is mostly behind you? So I'll kick it over to Ted first, and Greg, you can feel free to add on.”now that paid sharing is mostly behind you? So I'll kick it over to Ted first, and Greg, you can feel free to add on.”
On that last question, management did mention that cutting off password sharing will weigh on viewing metrics:
“As we have said, due to the work that we've been doing on password sharing, we're essentially cutting off some viewers who are not payers, and therefore, we're going to lose some viewing associated with that. So when you see our next engagement report, you are going to see some impact to our overall absolute view hours as a result of that.”“As we have said, due to the work that we've been doing on password sharing, we're essentially cutting off some viewers who are not payers, and therefore, we're going to lose some viewing associated with that. So when you see our next engagement report, you are going to see some impact to our overall absolute view hours as a result of that.”
Therefore, if password sharing becomes saturated, this could lead to paid net adds potentially flatlining as its been the primary growth lever for some of these knockout reports on paid net adds.
Demand Problem on Ad Tier
In the call, management pointed to there not being enough demand for the ad tier, which means not enough advertisers. This may change next month in the upfront season where top tier content providers court advertisers for upfront commitments in a highly publicized event, but for now, it’s creating a drag on ARM.
“In terms of how we're doing now relative to what we discussed when we first launched business, as Greg said, we've been growing our inventory at quite a fast clip. And so monetization hasn't fully kept up with that growth in scale and inventory as we're still early in building out our sales capabilities and our ad products. But that is an opportunity for us because this — we're still a very premium content environment, very highly engaged audience that's at an increasing scale. So our CPMs remain strong.
And we're building out our capabilities, as Greg talked about. So the revenue is going to follow engagement over time, and it's already kind of growing nicely, which is great just off a small base. So then really, as Greg said, what that means for ARM is right now, it is a bit of a drag on our ARM because of we're kind of under-monetizing relative to supply.”what that means for ARM is right now, it is a bit of a drag on our ARM because of we're kind of under-monetizing relative to supply.”
Therefore, the ad tier seeing a lag on demand could be the motivation for dropping ARM as a key metric come Q1 2025.
Lower Revenue Guide
The revenue guide being slightly lower at the midpoint was addressed on the call in terms of why there may be a slowdown by one or two points. Here is what management stated: “So our growth in the back half of '24 is really kind of comping off of those hard comps. And at the high end of our revenue forecast, our growth in the second half is consistent with our growth in the first half even with those tougher comps.”
The ARM in the UCAN region is a strong start as Netflix has recently raised prices in this region. EMEA may have broken it’s string of four quarters of decline due to increased prices in France and the UK being the remaining markets that saw price increases. However, it’s not going to be straight-forward ARM growth due to cutting-off password sharing leading to some lower priced tiers.
Per the call: “So mostly what you're seeing in our growth profile this year is the fact that we haven't taken pricing in most countries for the past 2 years really. And we also have some ARM kind of headwinds in the near term that you see in Q1. You'll probably see throughout most of this year, which is that, one, we have some — this plan mix shift as we roll out paid sharing. So it's — while it's highly revenue accretive, as you can see in our numbers, in our reported growth — strong reported growth in Q1 and outlook for the year, that – – as we spin off into new paid memberships, they tend to spin off into a mix of plan tiers that's a little bit of a lower price SKU than what we see in our tenured members […] And we're also growing our ads tier at a nice clip as you've seen and I'm sure we'll talk about. And monetization is lagging growth there.”
Conclusion:
This is a tough one because it’s a strong report at face value. This quarter was very impressive, and the nominally weaker full year guide feels a bit nit-picky to focus on. Overall, Netflix’s free cash flow guide of $6 billion and earnings growth over the next few quarters could sustain the stock, if needed. The company was wise to move toward efficiency and we have held the stock primarily for this reason as the foundation to our thesis while we participated in the speculative pivots of cutting off passwords and the ad tier. So far, one of those pivots has performed as planned (cutting of PWs) while the other pivot has been slow to monetize (the ad tier).
We are seeing important key metrics get dropped next year, which almost-always indicates an issue that management wants to get in front of. It’s interesting that Netflix rode out some tough quarters post-Covid with the pull-forward that occurred, yet kept these key metrics. In this case, it’s only natural to wonder if what’s ahead will be bumpier than the Covid pull-forward.
When you combine the fact that the key metrics could point toward the eventual saturation in cutting off password sharing coupled with a lag in demand on the ad tier, the next few quarters feel a bit like Russian roulette on when these two issues will intersect. It could be all blanks, and the juggernaut could march along and be rewarded especially for the bottom line, or these two could intersect and create a drag on both paid net adds and ARM at the same time. We are weighing these scenarios and our decision will ultimately be communicated in how the I/O Fund manages the position.
Damien Robbins, Equity Analyst for the I/O Fund, contributed to this analysis.
This article was originally published on Forbes on Nov 16, 2023,05:19pm ESTForbes Forbes on Nov 16, 2023,05:19pm EST
Apple’s Services segment was one of the brightest spots in a relatively in-line earnings report at the beginning of November, topping an $85 billion run rate as growth jumped back to the high double-digits after a string of single-digit growth. Services demonstrated that its growth flywheel continues to strengthen with multiple outlets of opportunity in sight — from AI, to further growth in the installed base, to price hikes across different Services bundles.
Services Growth Outpaces iPhone, Apple
Since fiscal 2018, Services has become increasingly important to both the top and bottom lines for Apple. The segment has seen its share of revenue rise from under 15% five years ago to 22.2% at the end of September. Since then, Services has seen its annual run rate increase from ~$40 billion to over $85 billion, on track to surpass a $100 billion run rate potentially as early as the second half FY24.
FY21 was a breakout year for Services – the segment recorded greater than 24% YoY growth and generated more than $10 billion in gross profit each quarter, as its gross margin neared 70%. Gross margin has continued to stay above the 70% range, rising as high as 72.6% in Q2 FY22.
Source: I/O Fund
FY23 ending in September saw a full year growth rate of 7.1% YoY for $85.2 billion outpacing both iPhone and company-wide growth, with Q4 being the strongest quarter of the fiscal year with a growth rate of 16.3% YoY. The I/O Fund recently covered Apple’s earnings report more in-depth following fiscal Q4 here.
Since FY18, Apple has grown revenue at a 7.6% CAGR, meanwhile, Apple’s company-wide gross profit has grown at a 10.1% CAGR over the same period with profits partly impacted by Services’ rising contribution and expanding margin.
Compared to Apple, Services is seeing revenue and gross profit grow at much quicker rates – more than 9 percentage points higher for both metrics. Since FY18, Services revenue has grown at a 16.5% CAGR, outpacing Apple’s 7.6% growth rate as well as the iPhone’s 4.0% CAGR, due to the unevenness in revenue in between upgrade cycles – iPhone delivered YoY revenue declines in FY19, FY20, and FY23.
Services’ gross profit has expanded at a 20.1% CAGR, rising around 150% since FY18, from $24.2 billion to $60.3 billion as gross margin has expanded 10 percentage points, from 60.8% to 70.8%. This strong revenue and gross profit growth over the past five years has seen Services gain importance to Apple’s margins and its bottom line.
Source: Apple
In FY18, Services contributed 23.7% of Apple’s gross profit, whereas today, Services contributes 36% of gross profit.
The breakdown looks like this:
As Services’ share of revenue rose from 15% to 22.2%, it helped pull Apple’s gross margin ~580 bp higher in just five years. Product gross margin – iPhone, Mac, iPad, etc. – increased just 210 bp, meaning this expansion in gross margin is primarily coming from Services.
FY21 was a breakout year for Apple’s gross margin, expanding from 38% to more than 42% because of that growth in Services. Apple is guiding for gross margin to expand further in fiscal Q1 next year, to the 45% to 46% range – an expansion of 200 to 300 bp YoY, with Services’ growth rate forecast to be in the high-teens again.
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Services Seeing Multiple Growth Outlets
Services growth has been broad based, with new revenue records across a range of different offerings, and the segment has multiple growth outlets to lever in the future, from growth in paid subscribers, AI, and price hikes.
CEO Tim Cook explained on Apple’s Q4 earnings call that the Services segment “achieved all-time revenue records across App Store, advertising, AppleCare, iCloud, payment services, and video, as well as the September quarter revenue record in Apple Music.” CFO Luca Maestri added that Services “reached all-time revenue records in the Americas, Europe and rest of Asia-Pacific and a September quarter record in Greater China.”
What is driving these record levels across multiple Services offerings and in every geography worldwide is solid growth in active devices and strong growth in paid subscriptions. Paid subscriptions have risen at more than 27% annually over the past five years to 1 billion by the end of FY23.
Source: APPLE
Apple has surpassed 2 billion installed devices, and “continues to grow at a nice pace and establishes a solid foundation for the future expansion of the ecosystem.” Thus, the organic growth flywheel for Services remains soundly intact – growth in installed devices driving growth in paid and transacting accounts at a higher degree.
At the start of FY18, Apple reported that it had an installed active device base of 1.3 billion devices, meaning it had a ratio of about 0.18 paid subscriptions per 1 active device. Since then, installed devices have grown more than +50% to over 2 billion, while paid subscriptions have grown nearly +360% to almost 1.1 billion, or a ratio of about 0.5 paid subscriptions per active device.
Reaching new all-time highs in its installed device base signals further growth lies ahead for Services, especially as the ratio of paid subscriptions per active device continues to rise. Other outlets of growth arise from Apple’s recent price hikes and potential monetization opportunities from AI.
Additional Levers
Apple recently enacted some price hikes for News+, Arcade, and its One bundles, with the hikes ranging from $2/mo to $5/mo. As a whole, the price hikes could generate an additional ~$5 billion in annual revenue with just a 15% attach rate to Apple’s more than 1 billion paid subscriptions — however, the price hikes could incur a small amount of churn, among more price-sensitive consumers.
In terms of AI, Apple is not releasing any details about projects in development, though it is rumored that some of the AI products Apple is working on would improve Siri and Messages’ capabilities, or add features to Keynote, Pages, and Apple Music. Apple’s large language model ‘Apple GPT’ is reportedly under development, but a commercialization route is still undetermined. The next-generation of Apple’s software, iOS 18, macOS 15, and watchOS 11, are poised to bring AI features to Apple’s devices next year, as it works to catch up in the generative AI deployment race against OpenAI and Google.
For any of its AI products, there are three routes that could boost Services revenue – adding AI features for free in an aim to boost engagement across offerings, charging a subscription fee for AI features, or increasing prices of current bundles that incorporate AI. For example, if Apple charged for a stand-alone AI subscription at a $2.99/mo price point, it could rake in ~$10.8 billion in annual revenue at a 15% attach rate to its more than 2 billion active devices; boosting the prices of all of its subscription bundles by $0.99/mo could also add more than $10 billion annually.
In a previous Forbes article “AI Could Be Apple’s Next Chapter,” my firm pointed out that: “although Apple is tight-lipped about the progress of its AI projects, the so-called Apple GPT chatbot is rumored to be more powerful than Open AI’s GPT 3.5 model, according to The Verge. Apple is spending millions of dollars a day training the large language model Ajax on more than 200 billion parameters.”
Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.
iPhone Demand Uncertain, China Risks Remain
Analysts have expressed concern over the holiday launch trajectory of Apple’s new iPhone 15, hinting that supply shortages, lower levels of consumer spending, and shorter wait times suggest weaker demand. The iPhone remains Apple's main source of revenue, and a conservative fiscal Q1 guide from the company along with heightened concerns over iPhone 15 demand add to risks that iPhone revenue growth in the near-term will remain depressed, after growing just +2.6% YoY in Q4.
Other concerns arise from Apple’s concentration in China, in regard to its iPhone supply base. Bank of America warned that Apple’s iPhone “supplier base remains largely in China,” which could “create many headwinds including around production, demand, [and] competition,” given that it is “hard to move all elements out of China.”
Services remains strong and a segment to watch, but we need the iPhone to participate and come in strong too, with a lingering risk to watch around China. Without the iPhone participating, Services is not enough to carry Apple’s stock alone, especially given its current valuation trading at levels hard to sustain.
Source: YCHARTS
Apple is currently trading at a 7.76x P/S ratio, above its 5-year median P/S ratio of 6.59x, with the 8.0x a level that Apple has struggled to hold on to since spiking to it in 2020. Apple is also trading at a nearly 28.8x forward P/E ratio, again another valuation level that it has struggled to hold on to – since late 2021, Apple has generally pulled back to below 24x forward P/E after trading above the 28 range.
Source: YCHARTS
However, another risk to watch is Alphabet’s antitrust trial, as it could have direct implications for Apple in the event of a negative ruling. Alphabet’s multi-billion dollar payments to Apple for Google to be the primary search engine on Safari across Apple’s devices is at the center of the trial, and that payment is rumored to be ~$19 billion this year – a key witness mentioned during the trial that Google is paying Apple 36% of search advertising revenue it generates via Safari. Should the scale of those payments constitute monopolization of the search market, Apple could be set to lose on a lucrative Services revenue stream.
Conclusion
Services is rapidly becoming one of Apple’s most important top-line segments, and arguably is the most important for Apple’s bottom-line, given its outsized role in boosting Apple’s gross margin. Organic growth has been a strong driver of Services’ +16.5% 5-year revenue CAGR and its +20.1% 5-year gross profit CAGR, both of which outpace Apple’s growth rates by more than 9 percentage points.
Should Services continue to grow in the teens for the next five years, such as at a 14% 5-year CAGR through FY28, it would be generating approximately $164 billion in revenue, or slightly more than 30% of Apple’s projected $538.6 billion in revenue. Price hikes, introduction of AI features, or finding ways to increase engagement and boost the ratio of paid subscriptions per active device all support this long-term revenue growth outlook for the segment.
Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.
The I/O Fund was early to AI with a 45% allocation in 2023. For more in-depth research from Beth, including 15-page+ deep dives on the 10 stock positions the I/O Fund owns, subscribe here.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Five quarters ago, we took a chance on entering Netflix in 2022 based on two things:
1. The upcoming pivot to monetize through ads and by cutting off password sharing. In the June quarter of 2022, Netflix reported negative net additions QoQ. This quarter, Netflix reported some of the best growth in recent quarters. Notably, ads are not contributing meaningfully. Password sharing is helping the company drive growth in paid memberships both YoY and QoQ following the December quarter.
Per management: “The cancel reaction continues to be low, exceeding our expectations, and borrower households converting into full paying memberships are demonstrating healthy retention. As a result, we’re revenue positive in every region when accounting for additional spin off accounts and extra members, churn and changes to our plan mix.”
2. Improved cash profile from negative (-$3.3B) in 2019 to a positive $1.6B in 2022. We had noted that management stated there would be substantial FCF growth in 2023. At the time, we had hoped for $3B to $4B in 2023. By raising FCF guidance every quarter this year, FCF will now come in at $6.5B. This is a phenomenal beat, although roughly $1 billion is from the Writer’s Strike. When adjusting for this, FCF is at $5.5 billion, which more realistically sets expectations for 2024 when content spend will be higher than 2023.
The weak spot in the report was average revenue per member, which declined (1%). Ideally, this improves with the price hikes the company announced today. This is reflected by a net paid addition beat that does not result in a revenue beat. With management guiding for similar net paid adds as Q3 (implying 9M) plus higher prices, the market is rewarding the stock because it’s assumed ARM will be higher next quarter. Netflix investors should continue to monitor lower ARM countries as time goes on as outsized growth here can potentially weigh on revenue growth. Last quarter, ARM was (-3%) and (-1%) on a CC basis.
Revenue and EPS:
Netflix reported revenue of $8.5 billion in line with management guidance and analyst consensus. This represents growth of 7.8% and 8% on a constant currency basis (CC). This is an acceleration QoQ from the 2.7% growth and 6% on CC basis last quarter. However, this is not an acceleration from the year ago quarter on a CC basis, which grew 13%.
Next quarter, Netflix guided in line for revenue of $8.7 billion for growth of 11% and 12% on CC basis. This will be an acceleration both QoQ (to be expected due to seasonality) and year-over-year with 10% growth on a CC basis in the year ago quarter.
Overall, Netflix’s revenue growth is expected to trend upward over the next few quarters.
The analyst consensus for adjusted EPS was $3.48 compared to $3.73 reported.
Operating Margin: A Bit of Confusion Following CFO Commentary Last Month
Analysts were expressing concerns going into this call about the FY2024 operating margin following a Bank of America conference when Spencer Neumann, CFO of the company, said:
“So I don't think given our scale now that we're at roughly 20% operating margins, I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”
This caused analysts to scramble and lower their price targets as some had a 279 bps estimate for next quarter.
For example, published on September 28th: “JPMorgan lowered the firm's price target on Netflix to $455 from $505 and keeps an Overweight rating on the shares ahead of the Q3 report. The firm's overall view on Netflix shares remains positive, but it lowered estimates to reflect recent comments from management around margin expansion. Investor conversations suggest increased concerns that paid sharing is less impactful than expected and providing less lift in Q4, while 2024 margin expansion could be less robust than anticipated, the analyst tells investors in a research note.”
Here's another one from September 22nd:
“Oppenheimer lowered the firm's price target on Netflix to $470 from $515 and keeps an Outperform rating on the shares following the CFO's comments at a conference. The CFO said he was "not expecting future operating leverage of 300bps" going forward, and while the comments are likely not intended to be guidance, the firm took notice, given its prior view of 279bps improvement, the analyst tells investors in a research note.
There are quite a few like this. The interesting part is that Netflix actually guided operating margin for FY2024 growth of 200 bps to 300 bps, or 250 bps at the midpoint. Therefore, the comments may have been taken out of context to mean future years (?) as the guide was strong all things considered.
Gross margin of 42.3% was in line
Operating margin of 22.4% was in line. Management stated the FY2023 operating margin would be 20%, which was at the high end of previous guidance of 18% to 20%.
Net profit of $1.68 billion was up 19.6%
For full year 2024, management stated they are expecting full year operating margin of 22% to 23%.
Cash:
Netflix repurchased $2.5B in shares and increased the buyback authorization by $10B.
The company’s cash flow margins are a highlight of the report. Operating cash flow of $1.992 billion represents a cash flow margin of 23.3%. Free cash flow of $1.888B represents a FCF margin of 22.1%. This is up from a FCF margin of 6% in the year ago quarter. This is outsized due to the writer’s strike.
Overall, Netflix has substantial long-term debt and always will. We’ve covered this extensively in the past as their business model requires high content spend. The gross debt is $14 billion and the net debt is $6.5 billion.
Per management: “expect FCF of $6.5B up from $5B prior forecast. The company repurchased $2.5B shares in Q3 and increased buyback authorization by $10B. As a result, we expect 2023 cash content spend of around $13B and, assuming the SAG-AFTRA strike is resolved in the near future, we are currently expecting cash content spend of up to ~$17B in 2024.
As we said last quarter, the strikes will create some lumpiness in FCF over the 2023/2024 period, but we still plan to deliver very substantial positive FCF in 2024.”
Key Metrics:
Netflix reported 8.7M net paid adds for a total of 247.2 million paid memberships. This is the highest number of paid net adds in recent quarters. Analyst consensus was between 6.5M and 6.9M. Per management, this was due to: “the roll out of paid sharing, strong, steady programming and the ongoing expansion of streaming globally"
Across the regions, ARM in APAC had the biggest decline at (-9%). The United States region technically declined (Netflix reporting this as 0%) from $16.37 ARM a year ago to $16.29 ARM in the most recent quarter. All regions added paid net additions.
Across all regions, ARM was down (-1%). As stated, look for ARM to resume growth following the price hikes that were announced today.
Management stated that “ads plan membership is up 70% QoQ.” This is not meaningfully contributing to revenue. According to the Investor Letter: “It’s been less than a year since launch. It takes time to build a new business from scratch, which is why we have said ad revenue would not be material to our business in 2023.
Regarding engagement, Netflix had the most watched Series for 37 out of the first 38 weeks of the year. Share of screen time was 8% and second only to YouTube.
Earnings Call:
This was an important statement in terms of Netflix’s expectations for future revenue growth based on cutting off password sharing. I’m liking the word “incremental” here:
“So we're going to continue the rollout for the next couple of quarters. I think folks are trying to figure out how much juice is left there. And I would say we anticipate that we will have incremental acquisition, incremental adds for the next several quarters. We've seen that in the last couple of quarters. I think also worth noting that, that was on top of also very healthy organic, meaning not driven by paid sharing growth. So we anticipate seeing that for the next several quarters to come.”
There was a lot of discussion on the ads business, but the main takeaway is that the ads business has not taken off yet. However, management seems to think by 2024 it will begin to affect net paid adds and ARM:
“So I would say just generally, when we think about 2024 and beyond, think about it as our revenue growth profile in general. And we talked about this recently. We expect a more balanced mix of membership and ARM growth in 2024 and beyond 2024. So just looking at 2024 specifically, as Ted talked about, we expect to have a great slate to drive the business forward. And we expect to continue to do things like add extra members, grow our advertising revenue, as Greg discussed.”
Conclusion:
Netflix is exactly where we hoped it would be in terms of its product story and fundamentals. There has been ongoing uncertainty around whether the company would do well with the pivot. The writer’s strike and new management team has added to this uncertainty. This quarter helped provide the market with more visibility that the juggernaut is right on track. The only blemish in the report is ARM, which is being addressed in the upcoming pricing increases. We are very early in the earnings season, yet as more companies report, I think Netflix will stand out as company handling a challenging macro environment with ease.
Five quarters ago, we took a chance on entering Netflix in 2022 based on two things:
1. The upcoming pivot to monetize through ads and by cutting off password sharing. In the June quarter of 2022, Netflix reported negative net additions QoQ. This quarter, Netflix reported some of the best growth in recent quarters. Notably, ads are not contributing meaningfully. Password sharing is helping the company drive growth in paid memberships both YoY and QoQ following the December quarter.
Per management: “The cancel reaction continues to be low, exceeding our expectations, and borrower households converting into full paying memberships are demonstrating healthy retention. As a result, we’re revenue positive in every region when accounting for additional spin off accounts and extra members, churn and changes to our plan mix.”
2. Improved cash profile from negative(-$3.3B)in 2019 to a positive $1.6B in 2022. We had noted that management stated there would be substantial FCF growth in 2023. At the time, we had hoped for $3B to $4B in 2023. By raising FCF guidance every quarter this year, FCF will now come in at $6.5B. This is a phenomenal beat, although roughly $1 billion is from the Writer’s Strike. When adjusting for this, FCF is at $5.5 billion, which more realistically sets expectations for 2024 when content spend will be higher than 2023.
The weak spot in the report was average revenue per member, which declined (1%). Ideally, this improves with the price hikes the company announced today. This is reflected by a net paid addition beat that does not result in a revenue beat. With management guiding for similar net paid adds as Q3 (implying 9M) plus higher prices, the market is rewarding the stock because it’s assumed ARM will be higher next quarter. Netflix investors should continue to monitor lower ARM countries as time goes on as outsized growth here can potentially weigh on revenue growth. Last quarter, ARM was (-3%) and (-1%) on a CC basis.
Revenue and EPS:
Netflix reported revenue of $8.5 billion in line with management guidance and analyst consensus. This represents growth of 7.8% and 8% on a constant currency basis (CC). This is an acceleration QoQ from the 2.7% growth and 6% on CC basis last quarter. However, this is not an acceleration from the year ago quarter on a CC basis, which grew 13%.
Next quarter, Netflix guided in line for revenue of $8.7 billion for growth of 11% and 12% on CC basis. This will be an acceleration both QoQ (to be expected due to seasonality) and year-over-year with 10% growth on a CC basis in the year ago quarter.
Overall, Netflix’s revenue growth is expected to trend upward over the next few quarters.
The analyst consensus for adjusted EPS was $3.48 compared to $3.73 reported.
Operating Margin: A Bit of Confusion Following CFO Commentary Last Month
Analysts were expressing concerns going into this call about the FY2024 operating margin following a Bank of America conference when Spencer Neumann, CFO of the company, said:
“So I don't think given our scale now that we're at roughly 20% operating margins, I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”
This caused analysts to scramble and lower their price targets as some had a 279 bps estimate for next quarter.
For example, published on September 28th: “JPMorgan lowered the firm's price target on Netflix to $455 from $505 and keeps an Overweight rating on the shares ahead of the Q3 report. The firm's overall view on Netflix shares remains positive, but it lowered estimates to reflect recent comments from management around margin expansion. Investor conversations suggest increased concerns that paid sharing is less impactful than expected and providing less lift in Q4, while 2024 margin expansion could be less robust than anticipated, the analyst tells investors in a research note.”
Here's another one from September 22nd:
“Oppenheimer lowered the firm's price target on Netflix to $470 from $515 and keeps an Outperform rating on the shares following the CFO's comments at a conference. The CFO said he was "not expecting future operating leverage of 300bps" going forward, and while the comments are likely not intended to be guidance, the firm took notice, given its prior view of 279bps improvement, the analyst tells investors in a research note.
There are quite a few like this. The interesting part is that Netflix actually guided operating margin for FY2024 growth of 200 bps to 300 bps, or 250 bps at the midpoint. Therefore, the comments may have been taken out of context to mean future years (?) as the guide was strong all things considered.
Gross margin of 42.3% was in line
Operating margin of 22.4% was in line. Management stated the FY2023 operating margin would be 20%, which was at the high end of previous guidance of 18% to 20%.
Net profit of $1.68 billion was up 19.6%
For full year 2024, management stated they are expecting full year operating margin of 22% to 23%.
Cash:
Netflix repurchased $2.5B in shares and increased the buyback authorization by $10B.
The company’s cash flow margins are a highlight of the report. Operating cash flow of $1.992 billion represents a cash flow margin of 23.3%. Free cash flow of $1.888B represents a FCF margin of 22.1%. This is up from a FCF margin of 6% in the year ago quarter. This is outsized due to the writer’s strike.
Overall, Netflix has substantial long-term debt and always will. We’ve covered this extensively in the past as their business model requires high content spend. The gross debt is $14 billion and the net debt is $6.5 billion.
Per management: “expect FCF of $6.5B up from $5B prior forecast. The company repurchased $2.5B shares in Q3 and increased buyback authorization by $10B. As a result, we expect 2023 cash content spend of around $13B and, assuming the SAG-AFTRA strike is resolved in the near future, we are currently expecting cash content spend of up to ~$17B in 2024.
As we said last quarter, the strikes will create some lumpiness in FCF over the 2023/2024 period, but we still plan to deliver very substantial positive FCF in 2024.”
Key Metrics:
Netflix reported 8.7M net paid adds for a total of 247.2 million paid memberships. This is the highest number of paid net adds in recent quarters. Analyst consensus was between 6.5M and 6.9M. Per management, this was due to: “the roll out of paid sharing, strong, steady programming and the ongoing expansion of streaming globally"
Across the regions, ARM in APAC had the biggest decline at (-9%). The United States region technically declined (Netflix reporting this as 0%) from $16.37 ARM a year ago to $16.29 ARM in the most recent quarter. All regions added paid net additions.
Across all regions, ARM was down (-1%). As stated, look for ARM to resume growth following the price hikes that were announced today.
Management stated that “ads plan membership is up 70% QoQ.” This is not meaningfully contributing to revenue. According to the Investor Letter: “It’s been less than a year since launch. It takes time to build a new business from scratch, which is why we have said ad revenue would not be material to our business in 2023.
Regarding engagement, Netflix had the most watched Series for 37 out of the first 38 weeks of the year. Share of screen time was 8% and second only to YouTube.
Earnings Call:
This was an important statement in terms of Netflix’s expectations for future revenue growth based on cutting off password sharing. I’m liking the word “incremental” here:
“So we're going to continue the rollout for the next couple of quarters. I think folks are trying to figure out how much juice is left there. And I would say we anticipate that we will have incremental acquisition, incremental adds for the next several quarters. We've seen that in the last couple of quarters. I think also worth noting that, that was on top of also very healthy organic, meaning not driven by paid sharing growth. So we anticipate seeing that for the next several quarters to come.”
There was a lot of discussion on the ads business, but the main takeaway is that the ads business has not taken off yet. However, management seems to think by 2024 it will begin to affect net paid adds and ARM:
“So I would say just generally, when we think about 2024 and beyond, think about it as our revenue growth profile in general. And we talked about this recently. We expect a more balanced mix of membership and ARM growth in 2024 and beyond 2024. So just looking at 2024 specifically, as Ted talked about, we expect to have a great slate to drive the business forward. And we expect to continue to do things like add extra members, grow our advertising revenue, as Greg discussed.”
Conclusion:
Netflix is exactly where we hoped it would be in terms of its product story and fundamentals. There has been ongoing uncertainty around whether the company would do well with the pivot. The writer’s strike and new management team has added to this uncertainty. This quarter helped provide the market with more visibility that the juggernaut is right on track. The only blemish in the report is ARM, which is being addressed in the upcoming pricing increases. We are very early in the earnings season, yet as more companies report, I think Netflix will stand out as company handling a challenging macro environment with ease.
EPS was a beat at $3.29 versus $2.86 expected. The previous free cash flow guide for FY2023 was at $3.5 billion, and the full year guide is now raised to $5 billion this year. The company beat on paid net adds at 5.9 million compared to 2.1 million expected. Notably, the beat on net adds is coming from paid sharing, to where you can pay a lower fee to be added to someone’s account. The beat is not coming from the ad tier.
There was a marginal miss on revenue at $8.18 billion compared to $8.29 billion expected. There was also a marginal miss on forward revenue at $8.52 billion management guidance versus $8.68 billion expected. These things may seem insignificant, but most tech stocks are priced to perfection right now.
The question is why did Netflix have such a big beat on net adds but not on revenue?
Negatives:
This is a blemish because in the past, the region grew 10% in revenue with similar net paid adds (reference Dec 2022 quarter), or there were no new net adds and still grew 9% in revenue (reference September 2022 quarter). Notably, even when Netflix lost 1.3 million subscribers, the company grew UCAN by 10% YoY on CC Basis. Therefore, it is unusual that Netflix did not grow revenue YoY in UCAN region, especially given the net adds.
Almost half of Netflix’s revenue comes from UCAN and so it’s watched closely. According to management, the UCAN region had benefited from increased pricing and is now only reflecting paid sharing plans. The UCAN region resulted in overall ARM being down 1%.
Today, separate from the earnings report, Netflix removed the basic, ad-free option for new subscribers in the United States and United Kingdom. New subscribers will have to pay $6.99 with ads or $15.49 without ads, eliminating the $9.99 tier.
On a side note, the ads ARM is expected to be $8.50, per management comments in the call.
Margins:
Margins were strong. Gross margin was flat yet operating margin was a beat by 330 basis points for an operating margin of 22.3% and operating income of $1.827 billion. Net margin also surpassed expectations by 260 basis points, which flowed to the beat on EPS.
Cash:
As stated, cash was quite strong at $1.44 billion in the quarter, up from $103 million a year ago. Management raised guidance from $3.5 billion in FCF for the fiscal year to $5 billion in the current fiscal year.
Earnings Call:
As stated, the primary blemish is related to UCAN. In the call, management emphasized overall revenue will accelerate yet could have been more clear about UCAN specifically.
This was stated at one point regarding ARM being down next quarter, as well: “But if you think about the drivers of average revenue per member, starting with the revenue drivers that we spoke about a moment ago, you can see our FX neutral, ARM is — it was down 1%, FX neutral in Q2 and we expect similar in Q3, flat to slightly down. That's mostly due to the limited price adjustments we mentioned over the past year in our big revenue markets in advance of rolling out paid sharing.”
Jessica Reif Ehrlich:
“Well, maybe you can help us think through like in UCAN, how much of the ARM growth is a function of add-on members to existing accounts versus new subs signing up to higher priced plans. And it sounds like from your letter that ARM will accelerate in the second half as you get further along in password sharing. Is that correct?”
Spencer Neumann:
“Yeah. Maybe just broadly thinking about our kind of revenue in Q2 and going forward. Jessica, the key is that we delivered revenue in line in Q2 with our expectations and we're on track to accelerate that revenue in Q3 and further accelerated in Q4. That's really our primary objective around revenue acceleration and we're set to deliver on it. But if we step back on thinking about our revenue growth and components overall or within a given region, it's driven by a combination of pricing, volume and new revenue streams like ads.
So if we think about each one of those, so we're now more than a year out from any price adjustments in our big revenue countries. We largely paused them during paid sharing rollout and so that's to be expected. For ads, that new revenue stream, we've expected a gradual revenue build and so that's not expected to be a big contributor this year. So continues to be on target. So most of our revenue growth this year is from growth in volume through new paid memberships and that's largely driven by our paid sharing rollout.”
The Hollywood strike is also a concern although management was bit vague about the implications other than saying: “These strikes, this strike is not an outcome that we wanted” and did not answer the question directly as to how much content they have in the pipeline before they run out. My takeaway was that Netflix’s stock will be impacted the longer the strike continues.
Conclusion:
Having a large beat on paid net adds but not translating that to revenue is not ideal. The company is being clear about revenue acceleration into the back half of the year, which means investors are being asked to be patient. We will likely be patient to some extent, but probably not at this allocation and with these gains. Overall, I imagine we will trim on this report. The stock has done quite well and we’d like to keep some of those gains given the weaker-than-expected quarterly report.
EPS was a beat at $3.29 versus $2.86 expected. The previous free cash flow guide for FY2023 was at $3.5 billion, and the full year guide is now raised to $5 billion this year. The company beat on paid net adds at 5.9 million compared to 2.1 million expected. Notably, the beat on net adds is coming from paid sharing, to where you can pay a lower fee to be added to someone’s account. The beat is not coming from the ad tier.
There was a marginal miss on revenue at $8.18 billion compared to $8.29 billion expected. There was also a marginal miss on forward revenue at $8.52 billion management guidance versus $8.68 billion expected. These things may seem insignificant, but most tech stocks are priced to perfection right now.
The question is why did Netflix have such a big beat on net adds but not on revenue?
Negatives:
This is a blemish because in the past, the region grew 10% in revenue with similar net paid adds (reference Dec 2022 quarter), or there were no new net adds and still grew 9% in revenue (reference September 2022 quarter). Notably, even when Netflix lost 1.3 million subscribers, the company grew UCAN by 10% YoY on CC Basis. Therefore, it is unusual that Netflix did not grow revenue YoY in UCAN region, especially given the net adds.
Almost half of Netflix’s revenue comes from UCAN and so it’s watched closely. According to management, the UCAN region had benefited from increased pricing and is now only reflecting paid sharing plans. The UCAN region resulted in overall ARM being down 1%.
Today, separate from the earnings report, Netflix removed the basic, ad-free option for new subscribers in the United States and United Kingdom. New subscribers will have to pay $6.99 with ads or $15.49 without ads, eliminating the $9.99 tier.
On a side note, the ads ARM is expected to be $8.50, per management comments in the call.
Margins:
Margins were strong. Gross margin was flat yet operating margin was a beat by 330 basis points for an operating margin of 22.3% and operating income of $1.827 billion. Net margin also surpassed expectations by 260 basis points, which flowed to the beat on EPS.
Cash:
As stated, cash was quite strong at $1.44 billion in the quarter, up from $103 million a year ago. Management raised guidance from $3.5 billion in FCF for the fiscal year to $5 billion in the current fiscal year.
Earnings Call:
As stated, the primary blemish is related to UCAN. In the call, management emphasized overall revenue will accelerate yet could have been more clear about UCAN specifically.
This was stated at one point regarding ARM being down next quarter, as well: “But if you think about the drivers of average revenue per member, starting with the revenue drivers that we spoke about a moment ago, you can see our FX neutral, ARM is — it was down 1%, FX neutral in Q2 and we expect similar in Q3, flat to slightly down. That's mostly due to the limited price adjustments we mentioned over the past year in our big revenue markets in advance of rolling out paid sharing.”
Jessica Reif Ehrlich:
“Well, maybe you can help us think through like in UCAN, how much of the ARM growth is a function of add-on members to existing accounts versus new subs signing up to higher priced plans. And it sounds like from your letter that ARM will accelerate in the second half as you get further along in password sharing. Is that correct?”
Spencer Neumann:
“Yeah. Maybe just broadly thinking about our kind of revenue in Q2 and going forward. Jessica, the key is that we delivered revenue in line in Q2 with our expectations and we're on track to accelerate that revenue in Q3 and further accelerated in Q4. That's really our primary objective around revenue acceleration and we're set to deliver on it. But if we step back on thinking about our revenue growth and components overall or within a given region, it's driven by a combination of pricing, volume and new revenue streams like ads.
So if we think about each one of those, so we're now more than a year out from any price adjustments in our big revenue countries. We largely paused them during paid sharing rollout and so that's to be expected. For ads, that new revenue stream, we've expected a gradual revenue build and so that's not expected to be a big contributor this year. So continues to be on target. So most of our revenue growth this year is from growth in volume through new paid memberships and that's largely driven by our paid sharing rollout.”
The Hollywood strike is also a concern although management was bit vague about the implications other than saying: “These strikes, this strike is not an outcome that we wanted” and did not answer the question directly as to how much content they have in the pipeline before they run out. My takeaway was that Netflix’s stock will be impacted the longer the strike continues.
Conclusion:
Having a large beat on paid net adds but not translating that to revenue is not ideal. The company is being clear about revenue acceleration into the back half of the year, which means investors are being asked to be patient. We will likely be patient to some extent, but probably not at this allocation and with these gains. Overall, I imagine we will trim on this report. The stock has done quite well and we’d like to keep some of those gains given the weaker-than-expected quarterly report.
This article was originally published on Forbes on Jun 1, 2023,08:15am EDTForbes Forbes on Jun 1, 2023,08:15am EDT
The smartphone market continues to be hit hard in q1, with prices down 20% and shipments down 13%, according to Canalys. Despite double digit decline across the industry, Apple delivered marginal growth on its iPhone sales at +1.5%. According to Counterpoint Research, Apple grew smartphone shipments by 1 million year-over-year from 59 million in Q1 2022 to 58 million in Q1 2023. The decline of (1.7%) was better than the (14%) decline for the global smartphone market.
Source: BETH KINDIG
According to Apple’s management, the reason the company was able to overcome smartphone weakness was due to sales in the emerging markets. The company’s CFO, Luca Maestri, said in the earnings call, “We set March quarter records in several developed and emerging markets with India, Indonesia, Turkey and the UAE doubling on a year-over-year basis.”We set March quarter records in several developed and emerging markets with India, Indonesia, Turkey and the UAE doubling on a year-over-year basis.”
Within the emerging markets, India is a primary focus for Apple due to a growing middle class. According to a survey from a non-profit, the middle-class population has grown from 14% in 2004-05 to 31% in 2020-21. Tim Cook also points to the fact that the country is at a tipping point. “There are a lot of people coming into the middle class, and I really feel that India is at a tipping point, and it's great to be there.”There are a lot of people coming into the middle class, and I really feel that India is at a tipping point, and it's great to be there.”
Although Apple does not break down India sales figures, Bloomberg News reported that sales grew by 46% YoY to about $6 billion for the trailing twelve months ending March 2023. According to a Wedbush analyst, “Apple is now aggressively looking at India from both a production and retail expansion over the coming years that the firm believes will be a strategic poker move for Cupertino that could ramp annual revenue to $20 billion by 2025 in India.”
Tim Cook recently visited India in April and opened two company-owned retail stores. Apple was the second biggest revenue generating brand in India in 2022, second only to Samsung as it gained 18% of the total value of smartphone shipments, according to research firm Counterpoint.
The company also plans to make India a manufacturing hub and this move is seen as the company’s efforts to rely less on China. JP Morgan mentioned in its research note last year that the company plans to produce 25% of all iPhones from India by 2025. However, it could take a few more years to reach the 25% level. According to Bloomberg News, the company now produces 7% of total iPhones from India and this is up from 1% in 2021.
Apple supplier Foxconn announced recently that the company plans to invest $500 million to set up a manufacturing plant in India. It had also announced in March that it received approval from another state in India for a $968 million investment. Similarly, Foxconn has plans to expand its existing manufacturing plants in India.
There are 2 billion Apple devices active in the world and there are 659 million smartphone users in India, compared to 975 million in China and 276 million in the United States. With India being second place, it makes sense that Tim Cook is focused here.
Source: Statista
According to Morgan Stanley analyst Erik Woodring, “The firm's 2023 revenue and EPS forecast increased by 1% and 3%, respectively, post-earnings and while the firm calls out iPhone 15 and an AR/VR headset as the next catalysts, it adds "don't sleep" on the emerging markets and India story at Apple.”
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Apple’s Brand Needs a Catalyst
Warren Buffet was recently asked why he is invested in Apple and his reply was “If you’re an Apple user and somebody offers you $10,000, but the only proviso is they’ll take away your iPhone and you’ll never be able to buy another, you’re not going to take it. If they tell you if you buy another Ford car, they’ll give you $10,000 not to do that, you’ll take the $10,000 and you’ll buy a Chevy instead.”
Not surprisingly, Apple is one of the world’s most valuable brands, rivaled only by Amazon and Google.
Source: I/O FUND
Despite this strong brand, the next chapter for Apple has been slow to materialize. As seen below, wearables have not become the “next big thing” for Apple with $8 billion or so in revenue per quarter. Emerging markets are promising, yet at the $20 billion per year or $5 billion per quarter, Apple will struggle to move the needle for some time by relying on this strategy alone.
“Investors looking for the “next big thing” will point toward companies like Stripe, Sofi or Square as the leading fintech stocks. Meanwhile, the next big thing to disrupt the financial sector may be sitting in plain sight. Apple grew its cash trove through legendary design and hardware, yet how Apple chooses to leverage its enormous reserve of cash may be what writes the next chapter for the world’s most valuable company.”
Services remain a long-term opportunity for the company to monetize its installed base of over 2 billion active devices. Apple recently launched a new high-yield savings account that offers a 4.15% interest rate, which is 10 times higher than the United States national average and 415 times higher than what Chase or Bank of America offers at 0.01%. Apple is also lending from its balance sheet for the first time ever through Apple Pay’s Buy Now and Pay Later product.
To illustrate how effective Apple’s move into finance tech has become, the cornerstone product, Apple Pay, currently has 75 percent adoption among iPhone users. This is up from 10% in 2016. In addition to taking on banks, Apple is also competing with Mastercard and Visa with features that allow merchants to use iPhones and iPads to send and receive payments. The long-term goal is to replace wallets with iPhones.
Spotlight on Earnings
For some time now, Apple has been a value stock. We discussed this when we stated:
“While comparing to other popular value stocks like Walmart, Apple is trading at a slightly higher forward P/E ratio of 23 compared to Walmart’s 19. However, the company’s net profit margin of 25.71% is very good compared to Walmart’s 1.45%.
Similarly, Apple has an excellent free cash flow margin of 26.37% compared to Walmart's negative free cash flow margin of -5.15%. This helps illustrate why Apple’s stock has held up well as investors are able to participate in the most cash efficient company of all time while also participating in the company’s future innovation cycle.”
The most recent earnings results continue to prove that Apple’s management team is strong on efficiency. Despite revenue declining by (2.5%) YoY to $94.84B, the gross margin improved from 43.8% to 44.3% in the most recent quarter, up 50 basis points due to cost savings and a favorable mix from Services. The free cash flow margin remained solid at 27% compared to 26.4% in the same period last year. The board also authorized an additional $90 billion share repurchase and increased the quarterly dividend by 4% to $0.24 per share.
Source: COMPANY IR
Operating income declined by (5.5%) and net income declined by (3.4%) YoY to $24.2 billion. EPS of $1.52 remained unchanged from the same period last year, and notably, the company beat EPS estimates by 6.4%.
As stated, iPhone sales were up +1.5% to $51.3 billion. Mac revenue declined by (31%) YoY to $7.2 billion. This was due to a strong comp with M1 MacBooks sales from last year and a weaker consumer. iPad declined (13%) YoY to $6.7 billion. Wearables declined (0.6%) to $8.8 billion.
Services grew 5.5% YoY to $20.9 billion.
Paid subscriptions of 975 million, was up 18.2% YoY. This segment is important as there is a higher gross margin of 71% compared to 36.7% for products.
Management’s directional insights for the June quarter were soft with foreign exchange negatively impacting growth by about 4%. The company’s CFO, Luca Maestri, said in the earnings call, “We expect our June quarter year-over-year revenue performance to be similar to the March quarter, assuming that the macroeconomic outlook does not worsen from what we are projecting today for the current quarter. Foreign exchange will continue to be a headwind and we expect a negative year-over-year impact of nearly four percentage points.”
Analysts expect revenue to decline by (1.1%) YoY to $82.03 billion.
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Where Can Apple Stock Go from Here?
There are two scenarios we are tracking for Apple based on the current price information:
The blue count suggests that we are in a long and drawn-out correction that will ultimately be targeting new lows. If Apple stays below $181.50 and then breaks below $150.50, the odds that this scenario is playing out will become very high. If this plays out, we will look towards the blue target box for a major low.
The red count suggests that the January low for Apple was a major one. This will put us in the final push in the large uptrend that began in 2009. If Apple can break above $181.50, we can see a final push to the upper red target box between $192 – $210.
Source: I/O Fund
Apple is currently under the major resistance zone between $176.25 – $181.50. Based on the relative weakness in most markets right now – small caps, industrials, materials, financials, transportation, the Dow Jones, as well as many global markets – we are expecting volatility to return sometime in early June. If Apple fails to punch through the $181.50 resistance before the market pulls back, it will need to hold the $160 – $150.50 range in order to allow for this final swing into the red target zone above. Below $150.50 and the top will be in for Apple, as the odds will greatly increase that we will be testing Apple’s January lows.
Conclusion:
My firm does not own Apple at the moment, yet given its enormous brand value and high install base, it’s a company we track closely. In addition, the company’s strong financials will only become more attractive in the event of a recession. For our purposes, my firm would want to see Services materialize as a leading Fintech play, and we would want to wait for the price action outlined above to play out before buying this stock.
The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund does not own shares in AAPL at the time of writing but may own other stocks pictured in the charts.
Royston Roche, I/O Fund Analyst, contributed to this article.
