Apple 'scales so well,' Argus Research Director explains

Argus Research Director Jim Kelleher joins Yahoo Finance Live to discuss Apple earnings and the strength of the company.

Video transcript

KARINA MITCHELL: Welcome back to Yahoo Finance. Well, Apple just reported historic results for its fiscal first quarter with growth in all product categories, except the iPad. Here to help us assess what the results mean, Jim Kelleher, Argus Research director of research. Jim, thanks so much for being here. So I just want to start off by saying you have a buy rating. The price target is $180.

I want to go over some of the results that we got from Apple yesterday. Revenue a beat at $124 billion. EPS $2.10 versus $1.90 expected. Flagship iPhone sales, $71 billion. Wearables, services, all beats. Historic record revenue in developed and emerging markets for the quarter. So I could go on, right? The stock is up today 5%, down 7% year to date. It took investors some time to warm up. I don't know what more they wanted because, you know, it took a while for the stock to climb up to 5%. I just want to get your reaction. What do you make of these results?

JIM KELLEHER: Well, the results are terrific across the board. And there's a great deal of operating leverage in the model. The revenue is very impressive. We've seen recovery in a key market for iPhone and for Apple products in China with, you know, well over 20% growth in that market. And we believe Apple became the number one smartphone in China in the quarter, not always by revenue, but by units. It's a premium priced phone. And for it to be the units leader in China's smartphone market is truly impressive.

But I want to highlight the operating leverage in the model. You've got 11% revenue growth, and yet, you've got 22% gross profit growth and 23% operating income growth. This company just scales so well. Here's a period in which, you know, Tim Cook said, for a second quarter in a row, more than $6 billion in foregone revenue due to supply chain. And almost all the technology companies I cover are seeing margin compression and lost sales that are resulting in lower EPS than expected in some cases, due to the supply chain constraint. Yet, Apple is able to kind of power through these things. You know, obviously, they're a preferred vendor for almost any supplier. That's going to be true, but they just operate so efficiently. And they do scale so well that their operating costs just don't grow as fast as their revenues grow.

KARINA MITCHELL: Yeah, size and scale definitely helping them there navigate better than many other suppliers. And Tim Cook did say that he expects, you know, supply issues to still persist and be a problem, but not be as much of a problem going forward. So that's something that he's able to address. I wanted to touch on the margin story because services have delivered the biggest margins, right-- Apple TV, Apple Card.

And now they're making a bigger push into that sector, doing direct payment with credit cards over the iPhone. But how do they handle going into this year when we know that multiple rate hikes are coming? So how do you handle growth is slowing, and customers may not be able to afford everything that they were able to afford? So how do they handle that?

JIM KELLEHER: You know, it's an interesting question. The rise in rates is probably more of a hindrance to the stock price than it is to Apple's operations. And for that reason, when rates rise, investors know to rotate out of technology. And they've done so. In the year to date, we've seen for the-- we've seen the technology ETF underperformed the market year to date and over the last year. So that's a challenge to the stock price.

But in terms of how does Apple respond to the rise in rates potentially impacting consumer spending, I would say that consumers are prioritizing spending on Apple products. And if something else has to suffer along the way, you're more likely to see that. So I don't see-- someone who really wants to buy an Apple Series 7 watch, someone who wants to buy a MacBook Pro, they're going to suck it up and they're going to make that purchase, and maybe they forego a few restaurant meals or maybe they forgo some other-- a leather briefcase or something. You know, I can't quite be in the mind of every consumer.

But I think Apple has successfully developed its ecosphere, so to speak. And people want to be in it, and they want to stay in it. And you made a point about services revenue growing. For years and years, Apple tried to build its installed base to get everyone on board, and now services just increases that installed base. It just keeps everyone in the Apple family. So once you're in for it, once you're in, you're going to kind of stay in. So, you know, again, consumer will respond to rising interest rates. Some spending will be crowded out, but Apple will remain a priority destination for money by consumers.

KARINA MITCHELL: And then to stay on top, how important is innovation to this company, to keep this constant supply of new products that appeal to its customers, to bring value to customers and to their shareholders as well in that case?

JIM KELLEHER: It's interesting. Tim Cook called that out. He said we've had eight quarters of the pandemic, and it's not getting any easier. But it's also unleashed some tremendous innovation among the Apple team. And innovation is kind of the lifeblood of Apple. Now we always consider them more of a product perfector than a product originator. They're always late to the game. They were late to the mobile phone. But they've obviously made the best mobile phone. And, you know, we continue to see that.

And you could see them trying their hands in areas like autonomous driving, but probably waiting for other companies to have a little more demonstrated success in that area and then arrive with the best solution. But I think they're mainly going to continue plowing the fields that they plowed so successfully. And that is primarily iPhone and Mac, both of-- Mac is enjoying a tremendous Renaissance, growing its revenue much faster than it's gaining market share, meaning consumers are willing to pay up for premium products.

KARINA MITCHELL: All right, we will leave it there. Thank you so much, Jim Kelleher, Argus Research director of research. Thank you.