Earnings Watch: Monster earnings week gets under way

Today’s Earnings Watch focuses on Apple (AAPL:xnas), Gilead Sciences (GILD:xnas) and Amazon (AMZN:xnas), because we have positions in those three stocks.

Ahead of Apple’s last earnings release (FY16 Q2), we expressed a very negative view and said that Wall Street was behind the curve. Back then we recommended going long put options to capture this perception spread between reality and the Street’s estimates.

Since the middle of May we have been short Apple / long Samsung as a pair trade, betting on Samsung to meet rising expectations due to its new successful lineup of Galaxy S7 phones. The pair trade also reflects our view that Apple’s miss in FY16 Q2 was not due to temporary factors in China but that underlying forces are more persistent. Chinese smartphone makers and Samsung have upped their game and produce equal, if not better, phones at much lower prices. Consumers are not excited about smartphones any longer, and during any saturation phase consumers increase their sensitivity to price.

Source: Saxo Bank

Apple reports FY16 Q3 earnings on Tuesday (2030 GMT) with analysts expecting earnings per share of $1.39, down 25% year-onyear, and revenue of $42.1 billion, down 15% y/y. We already know that Apple intended to reduce channel inventories by $2 billion in Q3 due to tepid demand for iPhones so the 15% y/y revenue decline will likely come true. Growth expectations for revenue over a two-year horizon have fallen to the lowest levels since 2005 with analysts expecting revenue to grow by only 3% over the next two years.

 

If Apple can just maintain their revenue level, for instance zero growth, then the current P/E ratio of 7.3 (adjusted for cash) should be around 10-20% higher. The risk is obviously margin pressure in the smartphone business lowering earnings even with stable revenue. This effect can be mitigated in the share price through share buybacks, and we expect Apple’s management to increase buybacks over the coming years as the company will have difficulty finding new project to invest the vast surplus from its operating cash flow. 

In addition these surplus cash flows will constantly push down the P/E ratio adjusted for cash (assuming earnings are stable), and over time bolster the floor under the share price. As a result of these forces, we are closing our short Apple position, but intend to keep our long Samsung position.

If a company is not a value case when its expected free cash flow over the next six years is equal to the current market value then nothing is. Gilead Sciences has been hit by investor anxiety over the US presidential election, which could bring big changes to drug pricing in the US. Furthermore, the company has recently disappointed on its pipeline of new drugs. 

The current valuation is basically putting zero value on Gilead Sciences’ drug development pipeline. It reminds us of how the market viewed AstraZeneca (AZN:xlon) back in 2012 when this stock was battered because of pipeline troubles. The stock has more than doubled since then on total return.

Sometimes it seems that analysts believe companies’ management is not able to change a situation. Who in their right mind would discount a future where Gilead Sciences’ management would not react on its pipeline if it disappoints again with acquisitions? We believe Gilead Sciences is a massively mispriced stock on a one-year horizon, and we are expressing that positive view in our SaxoStrats equity portfolio with a long position. The stock is also in our Alpha Picks top-40 global list. However, we acknowledge that investors need to be patient and that the US presidential race will be a drag on performance.

Analysts are expecting EPS of $3.02, down 4% y/y, and revenue $7.8 billion, down 6% y/y, with the company reporting earnings on Monday (after the market close).

It always start small, but suddenly you see it and then it is often too late to react. This describes the snowball effect, but also Amazon’s wild ride to conquer the world of e-commerce. With steady +20% y/y revenue growth in the past four years, Amazon stands out in retailing, but also in general in an otherwise low-growth economy. Even if this sounds crazy, we believe Amazon has just only finished the first inning and that it will become the first company to surpass $1 trillion in annual revenue probably within a decade. 

What will fuel this growth? First and foremost its international expansion which is still lagging the US segment as the international segment only stands for 33% of revenue, down from 48% in 2009. The shift in the revenue mix has been driven by Amazon Prime in the US, but over time, as the company rolls out its fulfillment centres in other countries, growth will pick up significantly again in its international markets.

In addition Amazon Web Services (AWS), which is currently expanding by around 70% y/y on annual $7.9 billion in revenue, will drive insane revenue as this service will become the dominant player in what will become the technology infrastructure for all digital companies.

While some investors constantly say that the stock is expensive, they are missing the compounding effects of the business and they certainly miss the fact that on a cashflow basis you are not overpaying for future growth. Two-year forward EV/EBITDA is 14.4, that's around a 40% premium to S&P 500, but not a steep premium for something growing at 20% y/y compared with around 1-2% y/y.

Amazon reports Q2 earnings on Thursday (after the close) with analysts expecting EPS of $2.37, up 147% y/y, and revenue $29.6 billion, up 28% y/y. We have a long position in Amazon since March 29, 2016.

Read the complete earnings release publication with estimates on earnings and revenue in the attached PDF.