Strength Across the Board, and iPhone X Hasn’t Even Started

Apple income statement here. Apple unit estimates here.

Conclusion. Tim Cook is giddy, and he should be. This was the first time since Dec-14 that Apple had growth in every product and every geography. Apple’s results for Sep-17 were generally as expected with two bright spots. First, Services growth was up 24%, an acceleration from 22% in Jun-17 and above Street expectations of 17%. Second, mainland China grew 12% year-over-year. The guidance for Dec-17 provided the substance of tonight’s surprise, with the midpoint of Dec-17 revenue 1% higher than the Street, and gross margins 25 bps above the Street (a rarity in a cycle change quarter). This guidance is noteworthy because it was likely driven by the iPhone 8 and older iPhones, not the iPhone X which remains in short supply. The iPhone X is of course the product that will make or break shares of AAPL over the next year. We believe demand for the iPhone X will, over the next four quarters, play out to be slightly more favorable than increasingly optimistic analyst estimates.

Can It Get Any Better? Revenue and gross margin guidance, despite investor concerns Apple would guide down, came in higher than expected. In addition, shares of AAPL are at an all-time high. This begs the question; can it get any better? We believe over the next two quarters the story continues to improve as the iPhone X inches ASPs higher (we’re modeling for $740 iPhone ASP in FY18, versus the Street which was at $722 prior to tonight’s results). Investor optimism may shift after Apple reports what is setting up to be a favorable Mar-18 quarter as the focus switches to anticipated lower growth in FY19. Historically, that shift has been negative for AAPL’s multiple in the near term. For some context, we’re modeling FY18 revenue growth of 22%, declining to 5% in FY19. It could take a couple additional quarters (Jun-18, Sep-18) for investors to regain their footing that the Apple story longer-term will emerge as a Services play, which should be favorable to AAPL’s multiple in the long-term.

An Expanded Definition of Services to Include Hardware. Apple’s Services business is doing well. As mentioned, growth in Sep-18 was 24%, an acceleration from 22% in Jun-17 (excluding one-time benefit). Next year, the Street is expecting Services to grow at 18% and account for about 14% of revenue. The incremental aspect to the Services story is the concept that iPhone owners are purchasing phones on a consistent basis that is beginning to mirror the predictability of a SaaS business. This goes beyond the iPhone upgrade program and taps into more than a billion iOS users that are increasingly becoming reliable as to when they upgrade their phone. This hardware as a service theme will likely manifest itself in an iPhone growth rate that is in the mid-single digits on a consistent basis. While this longer-term iPhone unit growth is below the hyper-growth Apple will experience in FY18, its stability should be increasingly valued by investors.

Cook Goes 4-4 Dodging iPhone Mix Questions. Give the sell-side credit, they didn’t give up easily when it came to getting a read on iPhone X demand. Of the seven analysts who asked questions on the call, four of them attempted to get a read on iPhone X initial demand or iPhone X mix. Cook graciously avoided answering the questions, but did add he “feels great” that iPhone X orders are “very strong” and he is “bullish” on the iPhone X cycle. He did throw investors a small bone with the insight that the iPhone 8 Plus has had the best start of any Plus model to date, which implies the iPhone 8 Plus is more than 60% of iPhone 8 units (iPhone 6 Plus was about 60% of units in its 2014 launch quarter). He also added that demand for iPhone X is “very strong” with consumers and carriers.

When Will We Reach iPhone X Supply-Demand Equilibrium? Based on current lead times, which are 5-6 weeks in the US and Asia and 3-4 weeks in Europe, we expect iPhone X will reach supply-demand equilibrium at the end of January.

Get Ready for Tomorrow. As you know, iPhone X goes on sale globally tomorrow. We couldn’t resist, and at 1PM ET we swung by the NYC Fifth Ave store to find 52 people waiting in line (the majority appeared to be from Asia, possibly buying the phone to resell on the black market). More to come tomorrow.

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