Apple Inc. (NASDAQ:AAPL) might appear nice and shiny after its release of third-quarter earnings, but beneath that nice skin lies some fundamental rot. It’s a difficult message to tell the longs, what with AAPL stock at all-time highs, but it’s a warning that every investor should heed regardless.
Let’s dive into the company’s fiscal third-quarter report.
Apple Earnings at a Glance
For its fiscal third quarter ending July 1, 2017, Apple’s net sales revenue was reported at $45.4 billion, which is up some 7% over the same quarter last year.
That was driven by some gains among its less core lines, such as a 6.7% gain in Mac laptop sales, as well as a 1.9% pick-up in iPad revenues.
But the news wasn’t as great for Apple’s primary product; the famous iPhone managed a sales gain of merely 1.9%, which isn’t what you want to hear out of a product that makes up 55% of the company’s sales.
But then the news doesn’t get so good as the primary product of the company – the famous iPhone just managed a sales gain of just 1.9%. That’s big because it represents the lion’s share of sales for the company at close to 55%.
And while the Services division — which includes its iTunes sales as well as its services for the iPhone and iPad as well as its watch, headphones and iPods — was up 22% year-over-year, the number wasn’t as impressive as it seems on its face. The company announced cuts or eliminations of some of the products in this segment last month. And again, it is dwarfed by the company’s out-sized reliance on iPhone sales.
Still, sales are one thing, and profits are another. This is where AAPL stock continues to show some rot.
Rising costs are weighing on operating margins. This is a great measure to look at. Operating margins look at revenue from sales and subtracts what it costs to operate the company to generate the revenues. This provides a cleaner view of profitability.
For the quarter, Apple’s operating margin was at 23.7%. That number is down from the same quarter in 2016, and continues the contraction from the company’s fiscal second quarter. So despite the gains in sales, costs are rising at a higher pace, squeezing profitability.
Let’s dig a little bit more into revenues — specifically, Apple’s major sales challenge. It can’t just be about what Apple sells in the U.S. and Europe. China, India and the rest of Asia are where the hefty growth in the smartphone market resides.
In China, Apple saw sales down some 10% from the same quarter in 2016 and down 25% from the second quarter of this year. Local Chinese smartphones from Huawei Technologies Co, Oppo, Xiaomi and Samsung Electronics Co (OTSMTKS:SSNLF) not only dominate and continue to expand market share, but their global sales continue to advance at double-digit rates that are eclipsing Apple, particularly in secondary and third-world markets.
And despite massive spending on Apple’s part, it continues to lag. It also has capitulated to local Chinese regulation forbidding certain non-approved encryption on iPhones and iPads as well as non-Chinese based data for its cloud and iTunes services. This is having a further drag on the appeal of Apple products for locals that increasingly see them as relics compared to local offerings.
Beyond China, there’s India, where AAPL faces major cut-throat competition from local phone companies. This includes free (yes, free) smartphones on offer from Reliance Industries and its Jio Network that is keeping potential Apple buyers on the fringe of that market.
Then there’s the battle of operating systems. Apple depends on customers adopting and staying on Apple products running on its iOS operating system. Without iOS, there’s no iPhone or iPad and no shot at expanding its services revenues.
In the U.S. alone, market research firm Consumer Intelligence Research Partners reported that in its most recent quarterly survey, iOS devices were only 31% of the market for new smartphones compared to 67% running on Alphabet Inc’s (NASDAQ:GOOGL) Android OS.
This isn’t just about a bad quarter for Apple’s iOS market share, but rather a continued trend for Apple iOS losing not just U.S. market share, but the global market share as well.
According to ongoing market studies conducted by IDC and Gartner, over the past five years there has been a continued slide in Apple iOS devices in use worldwide of some 29.4% to a mere 12% of the smartphone market.
Meanwhile, Android devices continue to gain ground rising for the same five years, by some 26.1% to a whopping 87%.
That’s the big battle that Apple is losing. It can’t just rely on a smaller offering of higher-priced iPhones as the market continues to expand. It has to acquire more customers — customers that are gravitating toward competitors in a broader universe of products.
As of this writing, Neil George did not hold a position in any of the aforementioned securities.