Weekly reading – 6th August 2022

What I wrote last week

Apple Q3 FY2022 Earnings

AWS, what a business!

Even with a loss of $2.6 billion, Uber had a great quarter

Business

($) America’s New Energy Crisis. A worrying report on the state of the energy supply in the US. Demand continues rise and unfortunately, so do oil prices. Projects to produce green alternatives take a long time to be completed and integrated into the national grid. “As U.S. power supplies tighten, developers are struggling to build these projects quickly enough to offset closures of older plants, in part because of supply-chain snarls. Another reason: It takes longer to approve their connections to the existing electricity grid. Such new requests neared 3,500 last year compared with roughly 1,000 in 2015, according to research from the Lawrence Berkeley National Laboratory. Typical time needed to complete technical studies needed for that grid approval is now more than three years, up from less than two in 2015. One renewable-energy developer, Recurrent Energy, filed more than 20 of these grid-connection requests last year in California, a state that needs more clean power to replace several gas-fired power plants as well as a nuclear plant slated for retirement in the coming years. It took the company seven years to get approval and construct a separate battery storage project in that state.”

($) JPMorgan Is Building a Giant Travel Agency. “It bought a booking system, a restaurant review company and a luxury travel agent. It is building its own airport lounges and a force of thousands of travel agents. A new website will launch in the coming months. JPMorgan estimates that its customers account for one of every three dollars spent on leisure travel in the U.S., though those customers book only a tiny amount on the Ultimate Rewards website. With the new offerings, JPMorgan executives believe the bank could capture $15 billion in bookings in 2025, five times what it handled before the recent buildup. That would make it the third-biggest travel agent in the country, based on 2021 volumes, according to industry publication Travel Weekly. The plan has risks. Travel-rewards giveaways have proved expensive for JPMorgan and other banks, and they haven’t always led to the lasting relationships the banks hoped for. JPMorgan also has important corporate partnerships with airlines and hotels that expect the bank to send customers their way. Some of those partners have already complained about the success of Sapphire taking away customers from their cards. The bank is already seeing early signs of that luxury demand. The average price Chase customers are paying for hotels is more than double the industry average, the bank said.”

From legroom to airfare: How JetBlue’s takeover of Spirit could change air travel. If you don’t know how expensive it is to travel domestically in the US, take a trip to Europe and try to fly within the continent. I was really shocked the first time I booked a domestic flight here. I am still shocked sometimes nowadays. There is competition between major airlines, but prices are still high because there is no regulatory pressure on a handful of airlines that fly customers. I don’t know if this merger will help anything. Having another major may drive air fares down. But it could as well join the fun and charge a lot.

US, Japan reaching for a 2-nm chip breakthrough. The race to secure semiconductor supply for the future amidst the political threat from China is more intense than ever. I don’t think China, regardless of whether Xi will be in charge, will give up Taiwan, home to TSMC. It’s not only because TSMC is THE fab of the most advanced chips in the world, but it’s also because China believes Taiwan belongs to them and has no rights to independence. Any nation’s leader will not fulfill their duty if they don’t think about hedging this risk. US and Japan are doing the right thing here. Better late than never.

Ad tracking rules could become much stricter in Europe; Apple’s ATT vindicated. Companies that rely on ads dollars should really pay attention. “This is the single, most important, unambiguous interpretation of GDPR so far. It backs up the approach of Apple.

($) Netflix Is Scrambling to Learn the Ad Business It Long Disdained. “One of Netflix’s goals was to secure a big “minimum guarantee”—a promise that it would get a large influx of ad revenue to limit its financial risk, say people familiar with the discussions. Netflix also hunted for a senior leader with advertising expertise, mindful that it knew little about the business of selling ads. The company approached at least two top Comcast executives for a senior role while the partnership negotiations were continuing with their employer, angering the top brass at the cable giant, some of the people said. Mr. Hastings has set lofty financial ambitions for the ad business. He and other company executives have told investors and ad industry executives privately in recent months that Netflix will eventually be able to charge advertisers about $80 for every 1,000 views of an ad by helping them target specific audience segments, people familiar with the discussions said. That would put Netflix among the most expensive destinations for ads, alongside top NFL television programming. Creating an advertising-supported tier isn’t the only about-face the company is making in its quest to revive growth. After years of treating password-sharing by customers as a marginal problem—Mr. Hastings said in 2016 he loved the practice—Netflix plans to begin charging households a sharing fee sometime in 2023.

Chip Makers Have a Message for Car Makers: Your Turn to Pay. The ever-growing demand for chips turns the negotiation tables around. Chip manufacturers now command more bargaining power than they ever have. Car producers have no choice but either put up or shut up. As every car company is now racing to bring electric vehicles and trucks to the market, they won’t shut up.

Other stuff I find interesting

Some wonderful photos of my country taken by an award-winning photographer

US regulators will certify first small nuclear reactor design. I understand that there are concerns over safety and nuclear waste, but nuclear is perhaps the best tool at our disposal to generate clean energy at scale to accommodate the ever increasing demand. I wonder how and/or if this step would help increase the use of nuclear power

Who Is Collecting Data from Your Car? An eye-opening read on the vehicle data world

Tails, You Win. Now that I think about it. Love is just pure dumb luck. The person that you fall in love with happen to love you back. If you manage to fall in love and spend the rest of your life with the same person, creating happy moments and sharing wonderful children and grandchildren, that’s as taily as tails get.

Biden wants an industrial renaissance. He can’t do it without immigration reform. As an immigrant myself, I can tell you that if I had known what I do now, I would not have come to the US. The immigration process here is very talent-unfriendly. The country pours billions of investments into technology, yet the immigration system is antiquated and undoes all the good that such investments bring. To secure the future of the US, the government needs to massively and quickly reform its immigration

Hidden menace: Massive methane leaks speed up climate change. It’s horrifying to learn that we are pumping an incredible amount of this polluter into the air while knowing that it can speed up climate change significantly.

The U.S. made a breakthrough battery discovery — then gave the technology to China. I could hardly believe what I read. A promising battery technology took a dozen US scientists, 6 years and millions of taxpayers’ money to be developed. Then, the Department of Energy transferred the technology to a company based in China where it is currently further developed and produced

Stats

HALF of the nation’s clean power is generated by nuclear energy

Gen Z has led all generations in terms of 30-59 day credit card delinquency this year, according to Vantage Score

OnlyFans has 200 million registered users

Globally, only 9% of plastic waste is recycled while 22% is mismanaged

Apple Q3 FY2022 Earnings

A well-managed company

Let’s go over the headline numbers first. Apple had a record Q3 result with almost $83 billion in revenue, a 2% YoY increase on the back of a 36% growth last year. The 1% decline in product revenue was more than offset by the 12% growth in Services, which hit almost $20 billion in sales. The company’s gross margin profile this quarter stayed relatively similar to the historical trends: 36% for Products, 71% for Services and 43% for the whole company. Operating margin was 28%, down 200 basis points YoY, while net margin dropped to 23% from 27% in Q3 last year.

Figure 1 – Apple’s revenue and YoY growth

Make no mistakes: this was a tough quarter. All companies had to deal with significant challenges such as the new variant of Covid-19, unfavorable foreign exchange headwind, supply chain constraints, the war in Ukraine and macroeconomic concerns across the globe. Big retailers like Walmart or Target reported higher expenses and lower profit guidance. Meta had the first revenue decline in history while incurring more operational expenses. Even the great Amazon saw a 4% decline in revenue from their famous eCommerce segment.

Figure 2 – Product, Service & Overall Gross Margin

Yet, we see Apple increase their top line, albeit modestly. Unfavorable foreign exchange rates were estimated to have a 300 basis point impact. Otherwise, the revenue growth would have been higher. On the other side of the equation, Apple stayed disciplined with their costs. Gross margin was relatively intact while the operating expenses (R&D and SG&A) were under controlled and rose only modestly. We all know how hard it is personally to stay disciplined with living expenses when disposable income grows. Hence, given the balance sheet that Apple has, they deserve praise for not wasting shareholders’ money on unnecessary acquisitions or ludicrous ventures.

For the next quarter, the company expected a 600 basis point impact from foreign exchange, better-than-this-quarter supply chain status and an acceleration in revenue growth. The positive note on revenue forecast is dire contrast with a somber tone from other companies, especially when we take into the size of Apple and the breadth of its operations across the world. Apple used to be a design firm known for the willingness to spend on products and services regardless of the cost. Tim Cook took over and steered the company towards a financially and operationally disciplined entity. It pays off handsomely.

iPhone and the resilient brand

Commentary from the management detailed how strong customer loyalty was towards the Apple brand. iPhone customer satisfaction stood at 98% and there were record switchers from other operating systems to iOS. Installed base for Mac, iPad and Wearables all reached a new all-time high. Over half of the new customers in the quarter were new to these products.

Apple products don’t exactly fall into the necessity category due to their high prices. As inflation hits consumers hard every country and supply chain issues still wreck multiple industries, it’s nothing short of impressive to see a 3% YoY increase in iPhone sales. That is robust proof of how dominant and what a great brand iPhone is. And we all know that once a consumer enters the Apple ecosystem, they are likely to buy more products and services. Therefore, investors can be more confident in the strength of Apple’s business amidst economic downturns, but there is NO guarantee that will happen.

Figure 3 – Apple Business Segments’ YoY Growth

Greater China

China still made up 18% of the total company, pretty much in line with the historical figures for Q3. According to Apple, China’s Services revenue grew faster than the company average of 24% and hit an all-time June quarter record. The growth in Services revenue was offset by the lower demand of products in China, due to the lockdown, albeit a push late in June. China’s operating margin dropped from 43% to 38%. Because Services, which has a higher margin, grew this quarter, the drop in operating margin is likely attributed to higher SG&A. Traditionally, Q4 is the weakest quarter for China, both in revenue and operating margin. I expect the revenue share and operating margin to drop to 17% and 34% respectively. It’d be great to have an analyst ask the management for more color on China in Q4.

Figure 4 – Apple’s Revenue broken down by geographic areas
Figure 5 – Geographic areas’ operating margin

Services

Per Apple:

Our Services set a June quarter revenue record of $19.6 billion, up 12% over a year ago, with all-time revenue records in the Americas and the rest of Asia Pacific and June quarter records in Europe and Greater China. We also achieved June quarter revenue records in each major Services category, including all-time revenue records for Music, Cloud Services, Apple Care, and Payment Services.

Source: Fool.com

Where are the critics of Apple’s growing Services? The pivot to Services a few years ago raised eyebrows, but eventually proved extremely fruitful and important to Apple. Not only does Services make customer experience on Apple’s devices better, but it also aids the company’s profitability with 70% gross margin. Since 2019, Services is the only part of the business that has had no down quarter and as of this quarter, made up 24% of the company’s top line. For reference, in terms of 4-quarter rolling average revenue, Apple’s Services is already bigger than Amazon’s AWS.

The number of paid subscriptions rose steadily every quarter over the past 4 years and hit the 860-million mark. At this rate, we’ll cross the 1-billion mark in the next 12 months. As the paid subscription population is highly correlated with Services revenue, the more subscriptions there are, the higher Services revenue grows.

Figure 6 – Apple’s paid subscription and Services revenue

Additionally, Apple’s commentary on the drivers of Services is very interesting. Apparently, the major contributors are Cloud, Apple Care, Payment Services and Music. The first three have high margin and are like to grow since they are sticky and central to user experience with Apple devices. How many use an iPhone without iCloud and Apple Pay? When, not if, this trend continues, it will do wonders to the gross margin of Services and the company.

One notable absence is ads. It’s understandable that this quarter saw some softness when the likes of Snap, Facebook or Google all reported slower growth than expected. But once this current economic environment subsides, ads will be a great lever to pull. Formerly limited to the Search tab on the App Store, Apple Ads was recently expanded ads to Today’s tab. More ads slots mean more revenue for Apple. These dollars also have high margin and don’t