Despite producing better than expected sales and profits, Apple is losing billions in additional profits to falling margins. It’s not too concerning yet as Wall Street took the stock higher after the announcement. However, it’s a trend that management will have to reverse before it becomes a problem.
Apple Inc. NASDAQ: AAPL popped a bit in afterhours trading after reporting their third quarter numbers. Shares spiked more than $9 following bullish surprises for revenue and earnings-per-share (EPS). The tech titan was forecasted to generate revenue of $53.39 billion with $2.10 per share falling to the bottom line.
Instead, management delivered sales of $53.8 billion, net income of $10.04 billion, and EPS of $2.18. In our Apple Earnings Preview, our proprietary outlook was for revenue of $53.58 billion, net income of $10.67 billion and earnings-per-share of $2.18.
Falling margins squeezing profitability was one of our concerns heading into Apple’s quarterly checkup, and they remain a concern following the announcement.
In the third quarter, cost of sales remained flat at 62.41% of revenue compared to the second quarter.
Total operating expenses were 14.49% for the three months ending March 30, 2019. They rose to 16.14% during the last three months. Monies allocated to Research and Development dropped to 7.91% of revenue in Q3 versus 8.48% in Q2. That means Selling, General, and Administrative (SG&A) costs jumped. The line item moved to 8.23% of revenue to 7.68%.
Put in English, Apple spent more per dollar on marketing to sell less stuff per dollar spent. Last quarter, Apple’s sales were $58.02 billion, and they spent $4.6 billion on SG&A. This quarter, SG&A was $4.43 billion with revenue of $53.8 billion.
SG&A generated $12.16 in revenue for every dollar spent in the third quarter. Meanwhile, the ratio was $13.01 to one in the second quarter. While not devastating, we’d prefer for their marketing efforts to be more efficient, delivering a bigger bang for the buck.
Third quarter net income as a percent of revenue slipped to 18.67% versus 19.93% three months ago. If the profit margins remained constant quarter to quarter, then AAPL’s diluted earnings per share would have checked in at $2.33. That’s a BIG difference.
On the plus side, inventory turned over 10 times during the quarter compared to 7.4 times in the second quarter. Getting inventory off the shelf could be a plus for margins down the line as the smartphone market replaces the old with the new higher priced items.
The overall financial health for Apple remains vibrant. However, small things are starting to add up, costing the company billions of dollars of additional profits. If the trends keep up long enough, it will become an issue.
In the meantime, as we mentioned up top, traders bid up AAPL shares nearly 5% to $218.13 in afterhours trading. Shares are now in the heart of resistance between $215 and $225, just shy of the 52-week closing high of $232.07 achieved on October 3, 2018.
Considering the technical traffic right overhead, it would not be surprising to see sellers emerge quickly if Apple shares move into the mid $220s. A true technical breakout couldn’t occur until shares closed above the 52-week high.
In the likely event the stock fails to make a new high, short-term trader types might consider taking some profits. Longer term investors should be satisfied with AAPL’s latest report card. However, they should keep an eye on margins.