Apple (NASDAQ:AAPL) reported stellar fiscal Q4 revenue and earnings on Oct. 28 for its quarter ending Sept. 30. Revenue was up 29% and its diluted earnings-per-share (EPS) was up 70% year-over-year. But that meant nothing to the market, as it fretted about Apple’s outlook. AAPL stock subsequently fell 2% after the report.
In fact, so far this year AAPL stock has not done that well. It has climbed nearly 16% year-to-date (YTD). This is well below the S&P 500, which is up 24.5% YTD.
In other words, Apple is significantly trailing the market average this year. The market and investors in AAPL stock are worried about the company’s near-term outlook. This is despite its huge profitability.
Where Things Stand With Apple
What concerned the market was the company’s comments about its soaring freight costs and its gross margins. Gross margins are the profits Apple achieves after taking into account its cost of goods sold (COGS). COGS generally include freight costs.
For example, Apple reported that its fiscal Q4 gross margins fell from 43.3% a year ago to 42.2%. That is a decline of 110 basis points or 1.1o percentage points. Moreover, its product gross margin fell from 36% to 34% or a drop of 170 basis points.
This amounts to a huge amount of money. For example, 1.70% of its product revenue of $65.08 billion amounts to $1.106 billion in lost income to the company.
That’s a big portion of its net profits. For example, $1.106 billion compared to its net income of $20.551 billion is 5.38% in foregone profits.
Moreover, Apple’s free cash flow (FCF) was $16.97 billion according to Seeking Alpha’s Cash Flow tab (operating cash flow minus capex spending). This means that foregoing $1.1 billion in cash flow was 6.5% of its total FCF for the quarter.
This is not only a lot of money but also a huge percentage of its profits and FCF that it can’t afford to give up.
Luca Maestri, the CFO, told investors in the quarterly conference call that they expect even lower growth rates: “We expect revenue for each product category to grow on a year-over-year basis, except for iPad, which we expect to decline year-over-year due to supply constraints. For services, we expect our growth rate to decelerate from the September quarter but to remain strong.”
However, concerning gross margins, the CFO was less positive: “We expect gross margin to be between 41.5% and 42.5%.”
This is even lower than the 42.2% fiscal Q4 gross margin and the 43.3% fiscal Q3 margin rates.
Tim Cook was more practical about the real cause of the lower gross margins:
“We’ve put our current thoughts in the gross margin guidance that we gave you, the 41.5% to 42.5%. I would tell you that we are seeing a significant increase in freight costs. And I would assume that that is pretty consistent across different companies. And so, we’re clearly seeing some inflation there.”
In other words, their freight cost problem, due to shipment delays — as is well known about the West Coast shipping ports — is not just their problem.
That provides little solace to AAPL stock owners. They have seen their stock fall as a result.
What to Do With AAPL Stock
The shipping crisis could play out over several quarters. I suspect that the Christmas quarter, for example, could also show lower gross margins.
That will continue to upset investors in AAPL stock. But it also provides a good opportunity to pick up AAPL shares on the cheap.
Patient value investors will try to take advantage of this opportunity and the position that AAPL stock presently is in.
One reason can be seen on the company’s fiscal year Cash Flow Statement on page 3 of its Financial Statements. It shows that Apple bought back $85.97 billion of its shares over the past year.
That works out to 3.50% of its total $2.46 trillion market value as of right now and would be higher based on its market value a year ago. In other words, despite the lower FCF margins, Apple is still likely to buy back more of its shares over the next several years. This is even after a 5% decline in its overall FCF with lower margins.
That gives plenty of reason for value investors to try and take advantage of this situation.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.