With Apple, We’re Back to a Familiar Tale

By any measure, the most recent earnings report for the fiscal fourth quarter of consumer technology giant Apple (NASDAQ:AAPL) was a resounding success. Robust growth in wearables helped to offset worries in overall declining iPhone sales. However, even iPhones put up very respectable numbers in Q4, beating expectations. And this ultimately bodes well for Apple’s transition to a services-based company.

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Or at least that’s the narrative. Admittedly, the earnings print gives Apple bulls substantial ammunition to counter any criticisms. On the top line, the company rang up $64 billion, up over $62.99 billion consensus target. For earnings per share, covering analysts forecasted $2.84. However, Apple delivered an EPS of $3.03.

On the product and services side, iPhone sales came in at $33.36 billion, exceeding expectations of $32.42 billion. For the all-important Services, it drew in $12.51 billion, beating out its consensus target of $12.15 billion by nearly 3%. Finally, Apple’s wearables sales experienced a 54% year-over-year lift to $6.52 billion.

The tremendous popularity of the AirPods earbuds made the wearables segment the fastest-growing unit of Q4. With smartphones already a saturated market, the momentum here couldn’t have come at a better time.

Unsurprisingly, Apple shares skyrocketed off the earnings disclosure. Excepting a few blips on the technical charts, it’s been a near vertical ride for the company. Apparently, the main criticism against the organization that it couldn’t diversify away from the iPhone was proven wrong.

To add gravy to the bulls’ portfolio, the U.S. and China agreed to a limited deal to stop their bitter trade war. Again, when that announcement was made, one of the beneficiaries was Apple.

So, is it time to chase Apple again?

Same Old Story for Apple

While Apple’s Q4 results were unquestionably impressive as a whole, the individual parts left me skeptical. Yes, we should give management credit for attempting to diversify away from the flagship iPhone. However, they’re nowhere near successful yet.

When you combine iPhone sales for the fiscal year 2019, you get a total of $142.4 billion. Compared to almost every other year in the second half of this decade, this tally is disappointing. For instance, in 2017, iPhone revenue was $141.3 billion, not much different from 2019 results. And 2015 and 2018 produced sales hauls that easily exceeded this fiscal year’s total count.

Furthermore, since 2015, iPhone revenue has decidedly gone flat. Based on current trends, we shouldn’t be surprised to see annual smartphone revenue regress, perhaps notably so.

Apple iPhone sales (annual basis)
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Source: Chart by Josh Enomoto

Interestingly, because overall iPhone sales were poor, this unit no longer makes up approximately two-thirds of total corporate revenue. For this fiscal year, smartphone sales account for just under 55% of Apple sales.

However, the allocation is declining for the wrong reasons: iPhone sales are down and other revenue sources like wearables and Services are still too far behind. And as it relates to Services, Apple is facing a familiar problem: the company needs robust iPhone sales to give credible viability to Services.

Back in 2016, Business Insider contributor Jay Yarow laid out this thesis very well. If Apple is going to go all in on Services, they need high-volume engagement. Essentially, this translates to cheaper iPhone prices. However, Apple is not in the business of cheap smartphones. If anything, these things are getting more expensive and exclusive.

When we talk about Services, we’re talking about app sales, iCloud revenue and iTunes, among other platforms. Generally, these are cheap expenditures. A $1,000 phone is not.

Technology Also a Threat

On the flip side, the risk to selling Apple now is the China factor. Presumably, the limited agreement will give way to a more permanent trade deal. Logically, this should open the company to a hungry Chinese audience.

While that could be the case, also consider the disruptive role of consumer technology. In recent years, Apple iPhone competitors like Samsung and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) have forwarded attractive alternatives. Right now, it’s very difficult to tell the phones apart strictly from features or performance.

Thus, when people buy iPhones, they’re paying a rich premium for the Apple ecosystem. Even here, technology is disruptive. Increasingly, digitalization initiatives are based off open-source innovations: think IBM’s (NYSE:IBM) Red Hat and their Kubernetes approach for the cloud. Simply, proprietary systems are steadily losing their appeal.

Whether you’re talking about American consumers or Chinese consumers, everyone wants a deal. And I believe all consumers will find it difficult to justify Apple’s premiums.

Besides, going back to the original point, Services revenues depend on selling lower-ticket items at mass volume. However, iPhones are losing the volume game (because they’re too expensive) which limits Services’ potential upside.

In the end, I’m left with too many difficult questions. Therefore, the recent lift in Apple seems an ideal time to take profits off the table.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/12/with-apple-were-back-to-a-familiar-tale/.

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