What's Going On With Apple's Inventory?

Apple (NASDAQ: AAPL) knocked its earnings report out of the park, but a couple of numbers seemed a little alarming at first glance.

In this Industry Focus: Tech clip, analysts Dylan Lewis and Evan Niu explain why a spike in Apple's inventory isn't as bad as it sounds, and is actually more of a smart, planned decision. They also discuss why Apple's ding from foreign exchange is nothing for investors to worry about.

A full transcript follows the video.

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This video was recorded on May 4, 2018.

Dylan Lewis: One thing I was a little surprised to see in this earnings release was a pretty big spike in inventory. We know Tim Cook as this guy who's a supply chain master. That was kind of his MO and his reputation coming into the CEO role. And it's something that Apple has very tightly managed for a really long time. We see that it spikes to over seven billion, the highest ever. What's going on with their inventory right now?

Evan Niu: Tim Cook has this famous line that he considers inventory to be "fundamentally evil," just because over time, if you build so much of it, it gets written down, and it's just a mess to deal with. It's very good to have lean inventory, enough to meet demand but not too much on your books, which is why this spike was so weird.

But it's really just actually component purchases. An analyst was able to get some clarity on that. I noticed it, too, initially, when I saw the balance sheet. Basically, CFO Maestri said, "We're basically making these purchasing decisions because of current market conditions." So, they're basically pre-buying all of these different components because the components, most specifically memory, the pricing is supposed to continue going up. I mean, it's been going on for two years, and it's probably going to keep going up, so they're basically just trying to buy as much as they can now to get ahead of continued price increases later this year. As we all know, they release a ton of iPhones in the fall, and they're going to need all those components to put them in the phones.

So, very specifically, the type of inventory that we're talking about is just components. It's not unsold products on shelves, which would be a pretty big concern there, if that were the case. So, it did jump out at me, too, but that's what's going on there.

Lewis: So, this is more of a planned decision than them sitting on stuff in a warehouse.

Niu: Right, exactly. [laughs] He was like, "It'll unwind itself over time," so really nothing to be concerned about, even though the numbers look a little scary.

Lewis: One other little tidbit from the call and from the release that I think is interesting, to go back to the conversation we were having about Facebook when we talked about their earnings, we both expressed some surprise at seeing a company have forex that was accretive. Usually, when you have money that you're bringing back from overseas from foreign operations and you're bringing it to the United States, because the dollar has been so strong for such a long period of time, that winds up being a ding on your top and bottom line. That was the case with what we saw here with Apple, where they wound up taking a slight hit for that.

Niu: Right. It was kind of the opposite scenario here. Facebook doesn't really have much of a hedging program in place to accommodate for these FX movements, which is why they got this benefit as the dollar continued to weaken. Apple is much larger, and obviously has a lot more money on the line, and in general, their business is much more spread across the world in terms of their supply chain. So, they have a much bigger and more active hedging program that kind of mitigates these foreign exchange movements, both up and down.

So, they tried to do their best to mitigate these hits that they've taken while the dollar was strengthening. And now that the dollar is weakening, they're missing out on the upside because these hedges are in place. So, it was kind of a funny thing, but it's because Apple does such a good job in general. If you're a company, you just don't want the risk at all. You just want to hedge it. You're not a currency trader, you don't want to ride the swings up and down. So, they just try to hedge it to mitigate all risk, up and down. So, yeah, they didn't get to enjoy some benefit like other companies.

Dylan Lewis owns shares of Apple. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.