Since the first iterations of the iPhone, Apple Inc. (AAPL) has operated on a fairly regular schedule, with one major upgrade coming every other year. Now, according to Japanese news site Nikkei, AAPL is stretching out that cycle from two years to three in the face of a slowing smartphone market.
I think it’s a smart move. The smartphone market has become oversaturated, and iPhone sales have grown more and more sluggish as a result. In fact, AAPL reported its first-ever drop in sales in the first quarter — a whopping 16% plunge to 51.2 million units from 61.1 million units the same quarter last year.
One recent criticism is that each new iteration only offers a few small tweaks — fingerprint identification, better touch sensitivity and a new spot for the audio jack — but nothing interesting enough to convince most consumers to upgrade.
What’s in Store for AAPL Stock?
From what we’ve heard about it already, this year’s iPhone 7 lineup will likely suffer from the same issue. We can look forward to new dual speakers and a dual camera system, but I think sales will be relatively lackluster given the rumors of a complete redesign for the 2017 iPhone.
CEO Tim Cook has hinted at the removal of the home button, an edge-to-edge display and other new features for next year’s model, which may entice consumers to save their money and ignore this year’s lineup entirely.
In the meantime, no one expects Apple to top the 230 million iPhones sold in 2015. This will be the first time annual sales failed to beat the year prior.
This all sounds like bad news, but the truth is AAPL is still a great company. It’s the dominant player in the cell phone industry, generates a lot of free cash flow, has a very strong balance sheet and is relatively cheap at 12X September 2016 earnings per share estimates (or even lower when you remove the company’s excess cash), with growth all but guaranteed in the long-term.
But I think some enthusiasts (including Warren Buffett) are underestimating the profit pressure Apple will feel in the coming years.
The slower replacement cycle and less differentiated technology will lead to more competition and pressure on Apple’s gross profit margins, which at 38% to 40% are very high for a hardware company.
And while the bulls like to talk about the growth of AAPL’s services business, which includes Apple Music, it’s only 12% of the current revenue base and may have trouble compensating for the decline in the company’s large computer hardware gross margin base.
Switching to a three-year upgrade cycle gives Apple’s developers more time to innovate and more time for consumers to shake off their “phone fatigue.”
If AAPL can find a way to keep its lineups feeling fresh, it shouldn’t have any problem holding its throne at the top of the smartphone market. But no one should expect the same explosive growth we saw back when AAPL stock was just a few years old.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
