Morgan Stanley Looks At The Good And Bad From Apple's Q2

Apple Inc. AAPL reported Tuesday its fiscal second-quarter earnings, which reinforced the bullish case for owning the stock, according to Morgan Stanley.

The Analyst

Morgan Stanley's Katy Huberty maintains an Overweight rating on Apple with an unchanged $200 price target.

The Thesis

There are five notable takeaways from Apple's earnings report, according to Huberty.

Services

Services revenue rose 31 percent from a year ago, which marks an acceleration from 27 percent in the prior quarter. Despite an already large scale of $33 billion in revenue over the last 12 months, Apple has multiple levers to spur incremental growth. These include Apple's broadening data center footprint and new payment methods generates a better experience, and ongoing growth in Music and Play would be coupled with upcoming services like Video.

iPhone

Apple guided iPhone shipments of 39 million units during its June-ending quarter, which does fall short of the analyst's estimate of 42 million a month ago but is "far better" than the revised 34 million unit estimate.

Margins

Apple's margin profile remains stable despite near-term headwinds such as Memory, which was a 70 basis point headwind to gross margins in the quarter, Huberty wrote. The company's management expects NAND prices to become more favorable in the near-term, while DRAM prices will likely fall later on this year. Apple's margins did benefit from a growing mix of Services revenue which rose from 10 percent last quarter to 15 percent and boasts a margin rate close to 60 percent.

Buybacks

Apple's capital return policy signals it prefers stock buybacks over dividends "in light of undervalued shares," the analyst wrote. The company should be able to complete $120 billion worth of share buybacks over the next six quarters, which would leave the company with $95 billion of net cash exiting fiscal 2019.

Inventory

Apple's inventory rose by $3.2 billion last quarter to $7.6 billion, which marks the biggest ever quarterly increase. The company is expected to reveal in a 10-Q filing this week that its inventory build is focused more on components than finished goods.