Apple faces blame game before it can shine again

For better or worse, Apple is still breaking records.

Despite the big let-down overnight, when the world’s best market-capitalised company posted its slowest ever iPhone growth, its first quarter results still had some highlights.

Apple’s $3.28 Q1 EPS, beat the street, again, as it has in each quarter for the last three years—consensus foresaw $3.23.

Revenue edged 1.7% higher to $75.87bn vs. the market’s $76.54bn expectation.

Both earnings and sales were the best Apple has ever made, and maintained its place as the most profitable company in the S&P 500.

These points will be worth remembering during the outpouring of negativity and perhaps even a ‘blame game’ that are likely to ensue among analysts and investors in the coming months.

In many ways after all, the ‘dream investment’ has given its many fans a rude awakening.

 

 

Blame the iPhone numbers game

At the root of Wall Street’s disappointment was the widely anticipated fading out of growth on a front that hitherto seemed almost indestructible—sales of iPhones.

Apple sold 74.8 million in Q1; another record, but year-on-year growth was its weakest ever.

Handset sales rose just 0.4% year-on-year.

Compare that with the next previous weakest year-on-year growth of 6.8% during a quarter in 2013, and 46% rise in Q1 2014.

And since Q1 was the first full quarter of sales including the latest handset model—iPhone 6S/6S Plus—it underscored that Apple’s latest phone was contributing little to total sales growth.

 

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With no let-up in sight seen in the medium term, the outlook darkened further.

Guidance points to 50-52 million handsets being sold in the ‘live’ quarter.

If the estimate is correct, it would be the first time Apple has sold fewer phones in a quarter year on year.

This has prompted much gnashing of teeth in the market.

In the same quarter last year Apple sold 61.2 million iPhones.

The subtext here is the fear that the ‘commoditization’ which has afflicted virtually every other aspect of the mobile telephone sphere may have, finally, arrived at Apple’s door.

 

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The view lacks plausibility though, in view of what is known about Apple’s phone market.

To start with, the majority of people who had an iPhone before the iPhone 6 have not yet to upgraded.

Hold-outs appear to be waiting for the next brand new model, iPhone 7.

60% of iPhone users bought theirs before the latest series was launched.

Independent research seems to tie these hold-outs back to future iPhones.

86% of US iPhone owners surveyed by Ipsos recently said they were somewhat or very likely to buy another.

15% of those were looking to upgrade and 17% said they wanted the next iPhone model (slated for September).

However, Apple CEO Tim Cook, and right-hand man, CFO Luca Maestri seemed determined to keep a lid on any optimism that might spring from those stats.

 

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Blame Tim Cook?

Although greater China sales—the fount of Apple’s most recent record revenues—rose 14% last quarter, there were dark clouds over that region too now, Maestri said.

“As we move into the March quarter it’s becoming more apparent that there are some signs of economic softness,” Maestri told reporters.

“We are starting to see something that we have not seen before.”

He was preparing the ground for weaker-than-expected revenue guidance.

‘Only’ $50bn-$53bn in total sales would be rung up now in Q2, not the $55.5bn the market was expecting and now even further below the $58bn booked in Q2 2015.

Again, bear in mind that the strong dollar skimmed some $5bn off sales in Q1, and assuming a similar amount in Q2, Apple would still meet the Street view.

 

 

Elsewhere, both Maestri and Cook, may have inadvertently opened up another front for the ‘blame game’.

That’s because their latest guidance contradicts Tim Cook’s commentary about how Apple was faring around the globe last year and particularly in China.

To be absolutely crystal-clear I’m not suggesting any wrong-doing here by Apple or any of its officers.

However, at the very least, there were discrepancies between Cook’s comments about conditions in China and what Cook and Maestri fessed-up to on Tuesday night.

A selection:

 

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• Apple earnings call, October 27, 2015

“I think that there’s a misunderstanding, probably particularly in the Western world about China’s economy, which contributes to the confusion. That said, I don’t think it is going as fast as it was, but I also don’t think that Apple’s results are largely dependent on minor changes in growth.”

 

• In letter to TV show host and former hedge fund manager Jim Cramer, August 2015

“I get updates on our performance in China every day, including this morning, and I can tell you that we have continued to experience strong growth for our business in China through July and August. Growth in iPhone activations has actually accelerated over the past few weeks. … Obviously I can’t predict the future, but our performance so far this quarter is reassuring.”

 

• Apple earnings call, Feb 10, 2015

“That country (China) has enormous opportunity. There’s such an amazing number of people that are moving into the middle class. It’s something like I’ve never seen in my lifetime before.”

 

 

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The bigger Apple

Once the ‘blame game’ plays out (possibly no later than September?) cooler heads may revisit the wider context of Apple’s current ‘troubles’.

For one thing worries about global smartphone market saturation seem premature.

China revenues still rose 14% to $18.37bn in the midst of the slowdown there.

Assume Middle Kingdom sales growth slows to single digits.

Apple would still be looking at $19.2bn if sales grew 5% more.

Not to mention that India and Africa of course are virtually bereft of native iPhone owners at this moment.

 

Elsewhere, Chinese rivals are experiencing challenges like Apple’s.

The crucial difference between the US company and its regional competitors however, is price point.

Low-margin handset maker Xiaomi, for instance, missed its target of $1bn in service revenue and handsets sales in 2015.

 

By contrast, Apple’s gross margin topped 40% during previous quarter, consistent with the full-year rate of 2015 and $38.59% in FY ’14.

 

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All in, whilst the first half of the year looks set to hold more challenges than perhaps the majority of individual Apple investors are used to, it’s premature to imply the story has soured permanently.

Bear in mind Apple’s current forward price/earnings ratio of less than 11-times 12-month earnings places it among companies growing much more slowly.

Apple’s rate is also a third below the typical S&P 500 company.

Putting the pause in revenue growth aside for the moment, the market is therefore undervaluing Apple’s nation-state size cash pile—$70bn in September.

On that basis, Apple stock may currently be too cheap.

 

That does not mean the shares should immediately recover after losing 17% since late October.

It just suggests Apple’s acclimatisation to more common global equity realities may have overshot common sense.

Even the simplest price target exercise—using 24-month EPS forecasts and Apple’s depleted price/earnings ratio—gives about $102.

 

 

 

DAILY CHART

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Still, as we pointed out last night, Apple shares right now seem tightly bound by meek sentiment, and that’s been the case for several months.

Getting back above former support and now likely resistance between $107 and $108 will be an even more difficult hurdle now.

As noted, the 24th August low (c. $92) also corresponds with AAPL’s 200-week moving average.

The stock has remained above the 200-WMA since 2013.

A more severe order of challenges than Apple currently faces would appear to be necessary to break this important support.

If prices around $90 do not in the end provide support, a rapid approach to weekly lows between October 2013 and April 2014 could be seen.

There seems little solid ground below $92 and before $75-$65.

Again, our view is that the weakest scenario is unlikely, if not impossible.

 

 

WEEKLY CHART

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