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Tech Stocks Update: Apple and Facebook

Facebook started 2017 on a positive note with revenue ahead of expectations, while Apple reported solid fiscal second-quarter results

Morningstar Equity Analysts 4 May, 2017 | 12:15PM

Facebook (FB)

Wide-moat Facebook started 2017 on a positive note with first-quarter revenue and operating income coming in ahead of expectations. While we are beginning to see deceleration in ad revenue growth, Facebook’s growing monthly average users continue to indicate the strengthening of Facebook’s network effect, which reaffirms the firm’s leadership in the social networking and online ad markets. Although the first-quarter operating margin exceeded expectations, management reiterated that the firm’s expense growth is likely to outpace revenue growth this year. We made only minor adjustments to our estimates and are maintaining our $135 fair value estimate for Facebook.

Growth in Facebook’s users continued to attract advertising dollars and generated ad revenue of $7.9 billion during the quarter, up 51% from the prior year. While Facebook is lowering ad inventory on its own properties later this year, for the time being, demand has remained strong, which has pushed up ad prices, as indicated by the 28% year-over-year increase in average revenue per user.

In addition, the firm has successfully added Snapchat-like features, such as Stories, to Instagram, driving the app’s users and user monetization higher. Overall, with more users and user engagement, Facebook continues to not only strengthen its network, but also possibly the value of its intangible assets stemming from user data.

Given the firm’s focus on video, we expect Facebook to spend more on increasing its short- and long-form premium video content to keep users on its platform and attract more ad dollars in the long-run.

Apple (AAPL)

Apple reported solid fiscal second-quarter results and provided investors with a third-quarter forecast that was relatively in line with our expectations and points to decent ongoing demand for Apple's products, even though the firm is already seeing customers pause on iPhone spending in anticipation of the company's tenth anniversary iPhone due later this year.

Meanwhile, services revenue grew nicely, which we think still bodes well for customer stickiness around the iOS ecosystem, which is the backbone of our narrow moat rating for the firm. Further, Apple boosted its quarterly dividend by 10.5% and added $35 billion to its share repurchase authorisation. We will maintain our $138 fair value estimate for Apple.

Greater China remains a bit of a near-term iPhone weak spot, although we wouldn't rule out pent up demand in this region for the next iPhone model either and we still like Apple's long-term prospects in the region. Services revenue grew 18% year over year, with 40% revenue growth from the Apps Store and double-digit revenue growth from Apple Music subscriptions and iCloud storage.

With each additional service, we think Apple is strengthening the switching costs around its iOS operating system, which will make customers less likely to switch to Android-based phones over time. Other Product revenue, including Watch, Airpods and Beats headphones, did relatively well and exceeded our expectations.

Similar to prior years, we anticipate that Apple investors will look past the firm's near-term results this spring and summer and look toward the company's upcoming product launches instead.

Apple has not yet incorporated any potential changes to U.S. corporate tax policy into its dividend or buyback programme. We believe that tax reform is more likely than not in the U.S. and expect the government to settle on a 25% tax rate; Apple earns roughly 40% of operating income from the Americas, excluding corporate adjustments. However, we estimate that a 10% repatriation tax on overseas cash, which is also a part of the U.S. government's early tax plans, would essentially negate any tax advantages from a lower ongoing U.S. corporate rate.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Apple Inc265.76 USD1.19
Facebook Inc A195.10 USD1.01

About Author

Morningstar Equity Analysts  Morningstar stock and fund analysts cover 2,000 mutual funds, 2,100 equities, and 300 exchange-traded funds.

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