On Tuesday night, Apple reported a record quarter.
Earnings, revenue, and most notably iPhone sales all crushed expectations, with the company selling more than 74 million iPhones during the holiday quarter.
Just huge, huge numbers. In fact, it was the most profitable quarter in corporate history, with Apple pulling in $US18 billion (!) in profit (!) in just one quarter (!).
But on the company’s conference call, analysts seemed to want to talk about one thing: currency.
Notably, how much would the strength of the US dollar hurt the company’s financial performance going forward?
In his prepared remarks at the top of the conference call, Apple CEO Tim Cook said, “Our results would have been even stronger, absent fierce foreign exchange volatility.” In fact, Apple’s CFO Luca Maestri said revenue growth would have been 4% higher in the holiday quarter had currency not affected results.
Maestri also noted currency in his prepared remarks about revenue for the quarter ending this March, saying: “We expect revenue to be between $US52 billion and $US55 billion, compared to $US45.6 billion in the year-ago quarter, and this represents a very significant revenue increase, despite growing foreign-exchange headwinds from the continued strengthening of the US dollar against most currencies.”
And this theme continued.
The first question the company fielded from analysts was literally, “can you talk about currency?” and no fewer than five separate analysts asked the company about how currency adjustments could impact results going forward.
But why is everyone so obsessed with currency adjustments? It was a record quarter!
To set the scene, here is a chart of the trade-weighted US dollar over the last year, showing how expensive the dollar is relative to other currencies. The dollar has been king.
This seems good, right?
Well, there’s a problem. Trade is a zero-sum game. One country exports stuff and another country buys that stuff. And this trade is facilitated with money, often US dollars.
And so most simply, the purchasing power of consumers who buy stuff in euros or yen has gone down relative to consumers that buy things in dollars. And vice versa. Now is a great time to take a vacation to Europe, for example, because your dollars will go further in Europe. (This is in theory: prices might not have adjusted, yet. But still.)
Here’s a simple example we highlighted on Tuesday of how the strong dollar hurts US earnings:
Here’s an interesting example that shows why US Multinationals are facing stiff headwinds from the strength of the Dollar: Just 5 months ago a product selling for 1,000 US Dollars would have cost a European 745 Euros. Today that same item would cost them 900 Euros. That’s a 21% price hike in just 5 months!
But the thing is, Apple doesn’t go raising prices on European consumers just because the euro has fallen. Instead, Apple takes the hit on their balance sheet in the form of reduced revenue and margins, and potentially earnings.
Only when things get crazy, like they did in Russia where the ruble has lost half its value against the dollar in just six months, does the company adjust pricing without rolling out a new product or a new upgrade cycle.
Here’s Apple CFO Luca Maestri on Tuesday’s call:
“[W]e prefer to adjust local pricing at the time of new product launches. That will be obviously our preference. That’s what we do in normal times. When currencies move as much as they have been in places like Russia for example, sometimes we need to take mid-cycle action to realign pricing. So we’ll see what happens. As you know currency markets tend to be very volatile. So we just want to understand a bit better what is happening.”
Right now in France, for example, a new iPhone 6 costs €709. Multiply this by 1.35, which is roughly what the euro was worth against the dollar six months ago, and Apple gets to book $US957.15 in revenue — in US dollars — on that sale.
Now, the euro is worth around 1.13 against the dollar, so that revenue due to Apple falls to $US801.17.
That’s a huge difference!
The job of a CFO, in part, is to hedge against these risks. So it’s likely that Apple is able to book the sale of that euro-denominated iPhone at something like 1.25 against the dollar because they hedge this risk in the currency market.
When you think about the crazy things that happen in currency markets, like what happened to the Swiss franc a few weeks ago, your first thought might be a bunch of Wall Street traders freaking out. Which is only partly true.
Multinational companies are also players in the currency market because they want to hedge their risk against huge currency swings. And Apple is no exception. Last quarter, 65% of the company’s revenue came from international sales.
On the call Maestri talked about Apple’s hedges, which he said should protect the company from some currency-related losses in the current quarter, though the future remains more uncertain.
What that means to us going forward for the March quarter is that revenue growth on a year-over-year basis in constant currency would be five points higher than what we are guiding to, if it wasn’t for the FX movements. In terms of gross margins, and you know that we look our gross margins on a sequential basis, the gross margin percentage after the offset that we’re getting from the hedging program will be impacted by over 100 basis points.
Now having said that, we have factored the impact that I just described into the guidance that we provided to you. So that’s where we are right now. Of course, as you look further out, you know we do not provide guidance past the March quarter, but it goes without saying that at current levels, again those headwinds will continue to become stronger for the reason I explained earlier, that our hedges continue to expire, they get replaced by new hedging contracts at current levels and so — and there is the impact that we would see during the course of the year.
It goes without saying strong U.S. dollar has negative impact on our international business.
So what this means is that if the dollar continues to strengthen, or even just remain strong, against other major currencies, then Apple is likely to face challenges increasing its revenue. Recall the euro example above.
And what do analysts and investors want? Growth!
Last quarter, Apple reported revenue that grew about 30% over last year. As we noted above, Maestri said this would have been closer to 35% had there not been so much currency volatility.
So people in the media, or people in the tech industry might be really, really excited about how many iPhones Apple is selling or about Apple Watch or maybe a new Apple TV.
But what Wall Street analysts and their investors care about is keeping the Apple story in tact. Namely, the incredible growth that Apple has been experiencing, and anything that puts this at risk is something analysts are going to ask and worry about.
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