Weekly Wisdom – May 9, 2024

By Hightower Great Lakes on May 9, 2024

Apple Services at an All-Time High

Have you ever used tap-to-pay, or a mobile wallet like Apple Pay, and wondered how exactly the technology works? Apple (AAPL) reported Q2 earnings last week with service revenues accelerating q/q and y/y to 14% – at all-time highs (with gross margins at 74.6%).

This segment is one of the fastest growing for the company. While the company does not break down the segment, it can be assumed it contains a combination of revenues from the App Store, advertising, AppleCare, iCloud, payments services, Apple Music and video revenues.

Following the record revenue for the segment, our team began pondering the world of mobile wallets and the increasing usage of near-field communication (NFC) payments.

Capital One shopping reported that in 2022 there were 3.4 billion digital wallet users worldwide­. A digital wallet is an application on a mobile device that allows users to pay for purchases directly from the device, rather than a physical debit or credit card.

As it may seem, younger consumers are the top users of digital wallets. 91% of Americans between ages 18 and 26 used digit wallets as their primary payment method in 2023. Also, consumers use a wide range of digital wallets, with Cash App and Apple Pay being the most used on a daily basis. It is expected that by 2026 almost 50% of total payment will be from digital wallets.

American Express (AXP) noted in its Q1 earnings release that younger generations are becoming a greater share of its customer base. Millennial and Gen Z spending was up 15% y/y and makes up 32% of its total consumer billed business. The company said that this age cohort has continued to see the most spending growth and that younger consumers use its cards more overall.

With that said, this is the same age group that is adopting digital payments the most. Relative to competitors, AXP is in a great position to react to the changing environment of a greater share of payments becoming digital.

One way they have already started doing this is through Instant Card Numbers – once approved for a card, instead of waiting for it in the mail, the card information can instantly be uploaded to a digital wallet, for immediate use. AXP will likely continue to find innovative ways to integrate digital use into its product and service offerings.

Chart 1: Digital Wallets Are Expected to be 43% of Total Transactions by 2026[1]

How Apple Pay Works

Apple Pay is most popular with younger consumers, such as Millennials and Gen Z. According to Stripe, Apple Pay has over 500 million users globally and has a 90% market share in the U.S. for digital wallets.[2] Importantly, more than 85% of U.S. retailers accept Apple Pay.

With Apple Pay, consumers can upload their payment information into their Apple Wallet. This eliminates the need to carry debit cards, credit cards and cash, and makes the personal device even more necessary to have everywhere you go. With simple touch or face ID, you can unlock the card and use NFC for tap-to-pay, which most payment processors include, and be on your way.

Apple has secure technology to make sure card information is safe. iPhones and other Apple devices have a dedicated chip, physically isolated from the rest of the device’s operating system, to store sensitive data such as biometric information.

The data is encrypted by default and will be rendered as unreadable if another person gains access to the device. Apple has real-time monitoring fraud detection systems and partners with third parties to follow security protocol.

Apple Pay Fees and Revenues

Credit card providers charge a number of fees, such as interchange fees and payment processing fees, for the use of their cards. The average credit card processing fees are 1.5-3.5% per transaction.[3] American Express (AXP) charges higher processing fees (1.4-3.3%) compared to other competitors, such as Visa (V) (1.2-2.4%).

American Express operates on a closed network, so only American Express can issue American Express cards, and thus control its fees. Business owners and banks cover these fees. Of course, AXP offers far greater benefits for its clients as a partial offset to the higher fees. 

When it comes to Apple Pay, Apple partners with major banks, credit card issuers and payment processors to integrate its systems into Apple Pay. Apple Pay generates revenues through transaction fees charged to banks.

It is reported that banks pay Apple approximately 15 basis points of each transaction to have the card uploaded and used on Apple Pay.[4] As Apple Pay is popular with younger generations, banks agree to pay this fee given the huge growth opportunity for all parties involved. Banks and the Department of Justice have pushed back in recent years on the fee, though Apple has not commented.[5]  

Apple Pay is expected to have over 700 million users by 2027. Apple Services, and especially Apple Pay, is an increasing growth driver for Apple’s business and has been a strong complement to Apple’s array of product offerings.

Chart 2: Apple Pay Global User to Hit 700 Million by 2027[6]

Finding Value Post-Earnings

At times, companies may report strong earnings that result in small to little stock price appreciation, or even invoke a sell-off. Investors may believe the reported earnings growth is already priced into the stock, or the earnings did not live up to expectations.  

We call earnings season “silly season,” as it creates opportunities for experienced investors. Below are a few stocks where we believe the market may be underappreciating the true strength of its earnings and opportunities:

Eaton Corporation (ETN)[7]

Eaton’s (ETN) first-quarter results beat earnings-per-share and revenue estimates, increased full-year guidance, and grew its gross margin by over 300 basis points y/y with free-cash-flow up 39% y/y.

ETN continues to reap the benefits of infrastructure spending with $1 trillion worth of announced megaprojects in the economy, up 100% y/y. The company has won $1 billion of orders with an electrical backlog of $11.3 billion and aerospace backlog of $3.4 billion.

They are in negations for another $1.4 billion in projects, and with a historical win rate of 40%, the negotiations can be expected to add another +$560 million to their backlog.

Management stated that they think the data center market will grow at a 25% compounded growth rate between 2022 and 2025. The stock fell around 4% following earnings and is back near its pre-earnings levels.

Shell PLC (SHEL)[8]

Shell (SHEL) beat earnings-per-share estimates by 24% in part from its integrated gas profits coming in at $3.68 billion, 34% above consensus of $2.74 billion. Shell CEO Wael Sawan said the results showed, “another quarter of strong operational and financial performance,” with the company announcing a $3.5 billion share buyback.

At a time when competitors are taking out more debt, SHEL reduced its net debt to $40.5 billion compared to $43.5 billion in the previous quarter. Management noted the improvement in their chemicals segment and said it was potential for further growth – in line with commentary from other companies. The stock reaction was muted following its earnings release.

Air Products and Chemicals, Inc. (APD)[9]

Air Products and Chemicals (APD) increased its EBITDA margin by 490 basis points in the quarter through pricing, cost discipline, and the pass through of lower energy costs. Its U.S. pricing rose 6%, and overall pricing 1%, both assisting in margin expansion.

Management noted that business in the U.S. and Europe was better than expected. We have been hearing a lot about electronic improvement, which would be a big tailwind for APD because they sell helium to electronic producers. The stock was mostly flat following earnings.

There are a number of other companies that we also believe reported strong Q1 earnings with stock prices that did not follow suit. Fortinet (FTNT) fell 9% following earnings, and we thought the sell-off brought an opportunity. FTNT beat total revenues by 120 bps and services grew 24% y/y with margins up 200 bps.

We believe the top players in cybersecurity will continue to gain market share and FTNT will benefit from this. GE Healthcare Technologies (GEHC) had difficult y/y comparisons in Q1 and confirmed guidance for the year.

The stock fell 10% following earnings, but it’s important to note that hospital CapEx is expected to double this year with higher utilization rates from Med Tech companies. SLB (SLB) has lagged year-to-date and has seen heavy activity in M&A markets recently.

The company reported a solid quarter and management was optimistic about international growth continuing, with internal revenues up 18% y/y. Its core businesses (reservoir performance, well construction and production system revenue) grew 13% y/y with operating margins up 200 bps.

Chart 6: Companies With Strong Q1 Earnings, But Have Been Underperforming[10]

Click here to read last week’s Market Note (5/2).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: Capital One. As of January 24, 2024.

[2] Source: Stripe. As of January 16, 2024.

[3] Source: Bank Rate. As of October 16, 2023.

[4] Source: WSJ. As of October 5, 2021.

[5] Source: Payments Dive. As of March 26, 2024.

[6] Source: Capital One. As of January 20, 2024.

[7] Source: FactSet (Chart). As of May 6, 2024.

[8] Source: FactSet (Chart). As of May 6, 2024.

[9] Source: FactSet (Chart). As of May 6, 2024.

[10] Source: FactSet (Chart). As of May 8, 2024.