Why the Apple Watch Is a Big Deal

In this episode of MarketFoolery, Chris Hill chats with Motley Fool analyst Brian Feroldi about the latest headlines and quarterly reports from Wall Street, including an impressive quarter for a logistics leader with shares hitting all-time highs. Despite higher than expected profits and record revenue, a popular software maker's shares were down. And the guys discuss the latest announcements from the Apple (AAPL -0.53%) event and much more.

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This video was recorded on September 16, 2020.

Chris Hill: It's Wednesday, September 16th. Welcome to MarketFoolery. I'm Chris Hill, with me today, Brian Feroldi. Good to see you my friend.

Brian Feroldi: Chris, great to be back.

Hill: We're going to get to Apple's event; for all the listeners out there, who're like, are you going to talk... yeah, of course, we're going to talk about Apple's event. But we've got some earnings to get to, and we're going to start with FedEx (FDX 0.04%), because shares of FedEx are hitting an all-time high today after first quarter revenue came in north of $19 billion. That is a record. And it's not just revenue, Brian, their margins are ticking up as well. And this was a really good quarter for FedEx.

Feroldi: Yeah, if you're a FedEx investor, I mean, pick a metric, it looked good. As you pointed out, $19.3 billion in revenue; a quarterly record. And that was up 13.5% year-over-year. For comparison, Wall Street was only expecting $17.5 billion. So, significant topline beat; not something you usually see with a company of FedEx's size. More impressive though, was the rest of the income statement, if you worked your way down, they really had some strong operating leverage. And they were actually able to grow their net income 67%. 67% growth in net income to $472/share; again, Wall Street only expected $269. It's not often you see that kind of delta for a company like FedEx.

Hill: It's not. And they didn't really give guidance, did they? Because in terms of what I saw this morning, I didn't see official guidance, but I saw some maybe encouraging signs out of FedEx in terms of the end of the year. FedEx is one of those companies that is certainly a bellwether for the consumer economy. And among other things, they said they're going to be hiring 70,000 seasonal workers; that's encouraging. That's up from last year when they hired 55,000 seasonal workers. And it seems like FedEx is gearing up for a strong holiday.

Feroldi: Yeah. They did not give official guidance other than their CapEx, but they did say that we are preparing for what we're calling the "shipathon," and we're going to prepare for [laughs] a peak like no other. And one reason that they called out that their growth was so strong this quarter was, huge volume growth in FedEx International Priority. One of the things they pointed out in the call was that a lot of their competitors from passenger airlines have cut a lot of their international flights. So, the sheer number of flights that are out there to ship packages has declined significantly. FedEx has been there to really fill that void like no other.

One other thing I found really interesting on the call was that they were previously predicting pre-COVID that in the U.S. the number of packages that were going to be delivered on any given day would hit about 100 million from e-commerce sales by 2026. They're now saying they think they're going to hit that by 2023. So, this is another sign that the move to e-commerce has been shifted forward multiple years, and FedEx is basically saying, we think it's been pulled forward at least three years. If you're invested in any e-commerce company that's got to be music to your ears.

Hill: It really does. And among other things, it validates what we've heard the last few months out of Walmart and Target, when they talk about, sort of, the way they have pulled that part of their business forward. I mean, a datapoint like that out of FedEx is a strong validator.

Feroldi: Definitely. And great time to be shipping things to people's homes. I know that the number of deliveries that are coming to my house are at an all-time high right now, and will probably remain there for some time. I'm sure it's the case for you too, Chris.

Hill: Shares of Adobe (ADBE -0.39%) are down a little bit today, despite the fact that Adobe posted record revenue in the third quarter. Profits also came in higher than expected. Why the pessimism from the short-term traders on Wall Street? Is this profit-taking, just because Adobe has had a great run over the past six months or so?

Feroldi: Or, you know, for the past 30 years, basically. [laughs] Adobe was one of those companies that I personally ignored for years, but this is an unbelievably impressive business, and this is a business at scale. And their quarterly results were fantastic. Again, pick a metric, it looked good. We saw revenue grow 14% to $3.2 billion; Wall Street was expecting $3.1 billion. Adjusted earnings were up 25% to $257; Wall Street was expecting $241. So, a strong beat on both numbers.

If you drill down into the results a little bit more, you see that their digital media segment, which is all the properties that most of us are familiar with, like Photoshop and Premiere, 19% revenue growth there. And that's a Software-as-a-Service business, so that's recurring repeat purchase revenue. And within that segment, they called out that their Document Cloud, which includes their Adobe Sign product, which is very much a competitor to DocuSign, growing very fast. The Adobe Sign 200% year-over-year, so that's great to see.

Their digital experience side, which is their business-to-business offering that helps with, like, marketing campaigns and automation, that only grew 2%, but there's a business in there that they're getting out of. If you'd strip that out, they actually grew 14%. Gross margin 87%. They bought back stock. I mean, pick a metric, it looked good.

Hill: It really did. And you're absolutely right about the long-term performance of this business. Although this is one of those businesses that, you know, a lot of times we like to -- yes, we talk about what's happening today or just this week, but we like to zoom-out and say, well, let's look at the five-year chart; that sort of thing. With Adobe, you can zoom-in at various points over the past 10 years, and you can see short-term, you know, pretty dramatic drops over -- you know, sometimes it's in reaction to earnings, something like that, but just -- you know, earlier this morning I was watching an interview on CNBC with Shantanu Narayen, who's the longtime CEO of Adobe. He's been there, I think, almost 13 years. I mean, he's been at Adobe longer than that, but he's been CEO for about 13 years. And my gosh! The stock is basically up 10X in the [laughs] time that he's been running that company.

Although I will say, I was struck by the fact that we can add Narayen to the list of CEOs -- and also on that list is Reed Hastings from Netflix -- talking openly about returning to the office, which I found interesting, because, you know -- and in the same way with Hastings, where it's like Reed Hastings runs a business that is predicated on people being in their homes. Adobe, in theory, thrives when people are working remotely. And yet Narayan was talking about wanting to get back to the office in a safe way, because of what he thinks that means for new projects. Something Hastings talked about recently as well. But regardless, I mean, the way Adobe has grown their business over the past decade in particular, it's just been amazing, and it's not for all of the -- the growth of the company for all of the great performance of the stock, it's not really a business that gets namechecked in the same way that we talk about some of the other big tech winners.

Feroldi: And yet, this is a company that's currently worth $230 billion. And I love that you called out Narayen there. He, to me, is an unsung tech hero. I mean, he has taken care of all of his stakeholders during his tenure. He's just been a fabulous leader. He's actually consistently ranked as one of the top CEOs according to employer rankings. If you look at his Glassdoor ratings, they are stellar, 95% CEO approval rating. Adobe itself gets "a great place to work." And as you pointed out, five years ago this was an $80 stock, after today's decline, $480 stock. So, Adobe has consistently won and Narayen is a big reason why.

Hill: Apple had their big event yesterday. No iPhone 12, but presumably that is coming next month, because Apple is going to have another event next month. But yesterday was busy, at least in terms of the number of announcements they had. They unveiled a new Apple Watch, new iPads, a personalized fitness service called Fitness+; because everything now has to have a "+." They also unveiled a bundle of services, sort of, bundling Apple Music, TV, Arcade, iCloud, Storage. So, there's a lot to go over there, Brian. Let me just step back and say, in your mind, what was the biggest thing they announced?

Feroldi: They did announce a bunch of incremental improvements. To me, the big takeaway here, the thing that excited me the most at least, was the new Apple Watch, the Series 6. It has a built-in O2 sensor that allows them to really catch up with Fitbit. I'm not an Apple Watch user myself. But to me, that is a great product for Apple to push. Once you have an Apple Watch and you use it consistently, that locks [laughs] you into the Apple ecosystem, like, almost as strongly as the iPhone. I can tell you my wife has been an Apple Watch user for years.

When we go on vacation, she has to take a separate charger with her just to charge her Apple Watch. And I'm like, can't you just leave that thing at home for a couple of days, and she basically refuses. I know there's a lot of other people out there that feel the same way. And Apple also launched a more affordable Apple Watch, the Apple Watch SE, which retails now at $279. It doesn't have the O2 sensor and it's a little bit slower, but that's a very affordable price point for a lot of consumers. They also have their older generation watches that are even lower priced.

So, to me, the big takeaway here is they're deadly serious about the Apple Watch. It's been a very successful product, and it expands the ecosystem. If you're an Apple shareholder, that's exactly what you want to see.

Hill: I agree with everything you just said, which is why it's interesting to me that the Apple Watch is not getting nearly the attention, at least in terms of the [laughs] financial media, that the Fitness+ service is getting and the bundle of services. So, let's dig into those a little bit. Shares of Peloton (PTON -1.29%) down a little bit today, shares of Spotify (SPOT -1.01%) down a little bit more today. I think that is probably due, in some small part, to Apple's announcements yesterday, whether it's the Fitness+ or sort of the bundling of Music. Just from a financial standpoint, the bundling move is an interesting one to me, because Apple's been doing a good job of making money from Apple TV, well, maybe not as much Apple TV, but certainly, Apple Music, Arcade, the iCloud storage. I was a little surprised by the bundling move, because they've certainly priced it in such a way that they want to try and get people into that ecosystem. And maybe the bet they're making with the bundling, Brian, is similar to the one with the watch, where it's like, if we can get more people into this, we can keep them there.

Feroldi: Yep, that's been Apple's secret sauce all along. Whenever they launch a product or a service, it reinforces all other products and services. And the fitness product they launched was $10/month or $80/year. And that's very much going directly after Peloton. I did a quick poll on Twitter just saying, do you think that this is a threat to Peloton? And of the 3,400 responses we got, almost two-thirds of people said, yes, this is a direct threat to Peloton. I'm not a Peloton user myself, but I do understand the appeal of the platform, but not everybody wants to spend a couple thousand dollars [laughs] on a bike or a treadmill. Apple, by offering these products directly into the Apple Watch and the iPad, could make that exact same service available to a lot of people very cheaply. And we also know that Apple has a billion [laughs] active consumers out there that they can push this to. So, I kind of agree, I think that this is a threat to Peloton. I don't think people are going to abandon their Peloton to switch over to Apple, but I do think, if you're on the fence about a Peloton and this comes out, this sounds like a pretty attractive option.

Hill: Yeah, I think you're right. I mean it's just a question of like, and we will find out as time goes on, how big a threat it is. I think people are whistling past the graveyard [laughs] if they think, no, this is not a threat, it's like, no, it is, at a minimum, it is a small threat to Peloton. And unlike video streaming, where there are multiple winners, in part because people have multiple streaming services, I think fitness and music are more of a zero-sum game. I don't imagine, you know, why -- if you're paying for Spotify, why would you pay for Pandora or Apple Music, and vice versa. If you're paying for Peloton, you're probably good in the fitness department and this isn't anything you need to go out and spend money on.

But certainly, to your point about the pricing, Apple is pricing this [laughs] in such a way that makes it easier to test into. You can say, I'm going to try this for $10 and just see how it goes as opposed to. Yeah, I'm going to throw down $4,000 on this Peloton bike [laughs] and see how it goes.

Feroldi: Yeah, and I do think that they're taking a Disney+ approach here to their bundling of the pricing. So, their top-tier program, which includes Apple Music, Apple TV, Apple Arcade, Apple Fitness, additional storage, Apple News, all of that combined is going to be costing $30/month. If you're a subscriber to one or two of those services, that's an attractive package right there for $30/month. I don't think Apple is going to make a ton of money at that kind of price point, but once you're in, once you're using it, I could definitely see Apple flexing some pricing power over time and kind of ramping that up slowly to improve its margin. So, I think it's a good move by Apple, and we'll just have to see whether or not Peloton responds to this by lowering prices or if their growth rate slows. We'll have to see.

Hill: We'll also have to see where the Fitness+ goes a year from now, both, in terms of what the numbers look like in terms of people signing up for this, but in terms of what else does Apple offer. I was thinking this morning about the launch of the first Apple Watch and the reaction to that device. And it reminded me of the launch of the iPad and the reaction of that device. And in both cases, you can -- you know, don't take my word for it, go back and look -- there was a healthy amount of skepticism for both the Apple Watch and the iPad. And a bunch of people saying, meh, I don't know about this. And Apple has -- you know, one more strength of that business is their ability to methodically improve devices over time, which is, at least in the case of the Watch, is I'm sure why your wife insists on taking it on vacation.

Feroldi: Exactly. And I think the O2 sensor is a pretty attractive feature. That is something that they've lacked, that's the one thing that Fitbit has had over them, so it's good to see them catching up there. I could see all these products selling very, very well. And the nice thing for Apple is, they're not depending on [laughs] Fitness+ being a huge hit, to them it's a thing that accelerates or strengthens their ecosystem. For Peloton, that's their business, [laughs] that's all there is to it. So, that's what you can do when you have the scale that Apple has.

Hill: Brian Feroldi, always good talking to you, thanks for being here.

Feroldi: You too, Chris.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill, thanks for listening, we'll see you tomorrow.