Right on cue, loyal fans and followers of Apple (NASDAQ:AAPL) interpreted last quarter’s numbers in the most positive light possible. Apple stock popped 5% on Wednesday following the Tuesday evening release of the company’s fiscal Q2 numbers, and Q3 guidance was everything the market says it wanted.
The glass-half-full response willfully sweeps one grave reality under the rug though. That is, for the first time since the advent of the iPhone in 2007, market dynamics are forcing Apple to choose between revenue growth or profit growth.
It’s not a development that sets the stage for the demise of the company. AAPL stock on its worst day is (still) a better investment than many other investment options.
Nevertheless, this is a name that’s driven by headlines more so than metrics. Sooner or later, enough commentators and analysts are going to latch on to this one subtle but important shift.
Quarterly Recap for AAPL Stock
For the three-month stretch that ended in March, Apple turned $58 billion worth of revenue into an operating profit of $2.46 per share of Apple stock. Both were down year-over-year, compared to $61.1 billion and $2.73 per share. And, both topped estimates of $57.5 billion and $2.37 per share, respectively. Its increasingly important services revenue grew, however, by nearly 10% to $4.1 billion.
That iPhone revenue though…
The company’s smartphone revenue rolled in at $31 billion, down from $37.6 billion in the year-ago quarter.
How many iPhones that was is anyone’s guess, since Apple stopped reporting unit sales of devices. But consider that the average selling price of the flagship device has inched higher. Simply put, Apple sells more of its pricier iPhone X series, and less of the iPhone 8 and iPhone 7. Therefore, the 17% drop in iPhone revenue obscures the scope of setback.
IDC estimates that unit sales of the popular smartphone fell 30%, from 52.2 million to 36.4 million. Trade turbulence can’t get all the blame.
Worrying Signs for AAPL Stock
Investors weren’t terribly fazed. Apple is becoming more of a services play and less of a hardware play anyway. Thus, declining sales of the iPhone don’t warrant much attention.
Except they do.
Along with the release of its fiscal Q1 numbers in late January, Apple readily touted the fact that its consumer base actively used 1.4 billion iOS-powered devices. Of that figure, 900 million were iPhones. This was the pool from which its services business would grow into a standalone powerhouse.
With this week’s report, Apple didn’t disclose how many iPhones were now in use. The only concrete indicator was that its total iOS active user base is “over 1.4 billion.”
It’s unlikely Apple lost active iPhone users during the first calendar quarter of the year. It’s possible the company didn’t want to divulge too many competitive details. Not saying much on the matter this week after it was so forthcoming three months ago, though, should raise eyebrows.
This, or That, But Not Both
Underscoring the concern that the iPhone franchise may be facing a brisk headwind is how Apple is inducing at least some of those sales. Bernstein’s Toni Sacconaghi noted on the matter:
“Apple’s confidence appears based on the fact that iPhone revenues picked up notably in March in response to price cuts in perhaps a quarter of geographies such as China (likely suggesting that Apple would have missed consensus expectations in the absence of such actions) and in response to attractive trade in offers at its stores and website.”
The fiscal victim was and is gross margins. Raymond James analyst Chris Caso crunched the numbers, concluding “Most interesting to us was implied iPhone gross margins, which appear to be down ~500 basis since December and down ~700 basis points since 2017, which could have a more material impact in 2H as iPhone ramps as a percent of revenue.”
For the first time in as long as many people can remember, Apple is being forced to choose between profits and sales. And either way, the growth in the number of active iOS devices needed to help boost service revenue may or may not be happening.
Looking Ahead for Apple Stock
All of this is what happens when a market is saturated and competing smartphone makers finally catch up. It also doesn’t help when competitors finally decide to take dead-aim at a dominant company.
And make no mistake: it’s happening in earnest now. Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) has accepted iPhones as credit toward the purchase of its Pixel smartphones for a while. But recently, Google upped the ante. They’re offering as much as $600 to consumers willing to swap their top-of-the-line iPhone for the Pixel 3.
It would also be naive to discount China’s cultural (and government-condoned if not government-planned) war against Apple. Chinese support of local smartphone-maker Huawei has made life difficult for AAPL in the world’s second-biggest economy. Huawei’s unit sales of its smartphones grew 50% last quarter. Not only did Apple miss those hardware sales, it’s going to miss all the ancillary service revenue those devices could have driven.
It’s not the end of the world for Apple. It’s a vulnerability, however, that has yet to be priced into Apple stock. The company can’t let last quarter’s dynamic become the new normal if services really are the future. It still has to grow its iOS base too.
As of this writing, James Brumley held a long position in Alphabet. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
