If any company out there needed a strong quarterly report this earnings season, it’s Apple Inc. (NASDAQ:AAPL). Not only did the world’s biggest and arguably most recognizable company post weaker year-over-year revenue as well as earnings in the prior quarter, but it fell short of earnings expectations for the first time in years, mostly thanks to a rarely-seen year-over-year decrease in iPhone sales.
AAPL stock immediately fell 6% on the news, and as of right now, Apple shares are down about the same amount as investors fear the situation hasn’t changed much.
Are investors right to be concerned? Is Apple a has-been, unable to reignite its growth rates from not too long ago? The jury’s still out on the matter, but the upcoming Apple earnings report may not go a long way in answering the question.
Apple Q3 Earnings Preview
Apple is expected to report a top line of $42.1 billion and a bottom line of $1.38 per share of AAPL stock for the quarter ending on June 25. The results for the company’s third fiscal quarter of 2016 will come after Tuesday’s closing bell.
Both numbers would be well below the same quarter’s figures from a year earlier. Revenue is expected to have fallen 15% from the year-ago top line of $49.6 billion, while earnings are projected to fall 25% from profits of $1.85 per share.
Waning iPhone sales are the biggest culprit in the demise of Apple’s past and projected numbers. They account for roughly two-thirds of the company’s revenue, and analysts expect another sizable year-over-year drop in unit sales for the third fiscal quarter. After falling 16% in the previous quarter, the pros are calling for sales of about 42 million iPhones for the recently completed quarter. That figure would be down 12% versus the fiscal Q3 tally of 47.5 million iPhones sold for 2015.
Services — things like Apple Pay, Apps and iTunes — are expected to generate $6 billion worth of revenue, up 20% on a year-over-year basis, matching the year-over-year growth rate the services division mustered in Q2. On a sequential basis, though, that wouldn’t be any better than Q2’s $5.99 billion in services revenue.
3 Things for AAPL Owners to Mull
Obviously several factors are in play with Apple here, but some are going to push the value of AAPL stock around more than others. The three biggest influences are (in no certain order):
1. iPhone Sales: Although Apple is working diligently to get away from so much reliance on the big-but-volatile revenue contribution makes to the company’s top line, it’s still the breadwinnner, and probably will be for a while.
That’s what makes the recent deterioration of its sales numbers so alarming.
Not everyone feels this weak patch is a permanent problem, however. Morgan Stanley analyst Katy Huberty recently suggested, “We expect Apple to report in-line June quarter results, and guide September quarter slightly below consensus estimates. We like the set-up as iPhone growth likely troughed in June and we expect a more revolutionary iPhone cycle next year,” anticipating the iPhone 7 and then the iPhone 8 will reignite new-purchase demand while accelerating the upgrade cycle.
2. Services: Tim Cook seems to have finally embraced the fact that sales of razor blades should be given the same time and effort as sales of razors. That is to say, an iPhone or an iPad or a Mac isn’t just a profit center in and of itself. It’s a platform from which another important profit center can be grown — sales of things like digital music, apps, and Apple Pay, just to name a few. Services is a relatively small piece of the pie, but it’s growing fast. It also produces very high-margin revenue.
Some have anticipated Apple’s service business ambition would hit a wall sooner than later. What that doubt doesn’t recognize, however, is that the company has only scratched the surface of the 1 billion active users of Apple devices, most of whom don’t fully utilize what that device can do.
3. China: Although China has been nothing but a headache for Apple over the course of the past several months, if AAPL is really going to fire on all cylinders, it needs to be able to compete there.
It hasn’t been easy. In June, the iPhone 6 was banned from sale in China until a patent dispute with a Chinese phonemaker had been settled. Earlier in the year the PRC government shutdown Apple’s iBook and iTunes Movie division. In the past, Apple has been the victim of a celebrity shaming campaign in China. Putting it all together (and more), it makes it tough for Apple to market to the country’s 1.3 billion consumers.
Bottom Line for AAPL Stock
While the rhetoric is grim, don’t be shocked if the Apple earnings report Tuesday evening is better than expected — the numbers are low, and likely meant to be beat. But it won’t mean much if they’re beat, now will it mean much if they’re not. The value of AAPL stock is about where the company can prove it’s going six months from now.
iPhone saturation is a legitimate problem, and though some observers think the iPhone 7 (and especially the iPhone 8) could create heroic demand, they were saying the same thing about the iPhone 6, and its initial demand fizzled pretty quickly. Ditto for the iPhone 6s.
Meanwhile, Services revenue is expected to have stagnated, sequentially. While this still is a huge opportunity, Apple hasn’t exactly figured out how to convert Services into big-time revenue.
In other words, Apple’s Q3 earnings won’t predict a grim or a fruitful future. Don’t read too much into them either way. The report is mostly just a place holder, as Apple is en route to something else.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.