AAPL Preview: Services Offset Slow iPhone in China

AAPL Preview: Services Offset Slow iPhone in China

Apple reports Tuesday, July 30th. Investors view the Jun-19 quarter as marking time to a 5G iPhone, which will likely be announced in the fall of 2020 and separately a read on the impact of the China trade dispute. While 5G will emerge as a measurable positive for Apple Shares, it’s only part of Apple’s long-term story, which deserves a higher multiple inline with other large tech companies.

High Level on June & Guidance

  • Jun-19 will be representative of the balance of 2019 – an overall business flat to down 2% (with iPhone revenue down about 12%, and Services up 15% plus).
  • For Jun-19, we expect revenue and earnings in line with consensus of $53.4B and EPS of $2.10, implying flat revenue, compared to a 5% decline in Mar-19 and Dec-18.
  • For guidance, we expect the high end of the Sep-19 revenue outlook should be in line with the Street’s $61.0B estimate. Apple typically comes in at the high end of its guidance range.

Product Lines

  • Investors have written off the iPhone this year, comfortable with what will be about a 12% decline in sales because Services (18% of revenue) will bridge the gap to the next iPhone cycle.
  • iPhone revenue will likely be down about 12% in Jun-19 vs down 17% in Mar-19. It gets slightly worse in Sep-19, with iPhone revenue likely down 13%. For Dec-19, iPhone revenue should be flat year over year.
  • Apple needs to grow Services at 16% in Jun-19, which would be consistent with the Mar-19 growth.
  • Margins need to be stable from Mar-19 with Services gross margin at 63.8% and product gross margin at 31.2%.
  • We expect Greater China to decline to 11% of revenue, compared to 13% in Mar-19 and 16% of revenue in Dec-18.

Open Questions

  • The most obvious question – what’s the future impact of the trade dispute both on China demand and how the Chinese government views Apple?
  • Apple’s privacy-first approach shelters them from most headline risk around consumer data practices, but investors will want to gain a more informed view on how the company would respond to greater government oversight on tech.
  • As for the timing of achieving net cash neutral, the company has not disclosed a timeframe to date.

Beyond the next iPhone

  • The Street believes the upcoming iPhone to be announced this fall will add only incremental features, but given the easy comps next year, the upgrade should be enough to return the iPhone business to up 3-4% in FY20 vs down around 15% in FY19.
  • There is a nominal risk to iPhone sales next year from consumers holding off until a 5G iPhone is available in the fall of FY20.
  • For FY20, the Street is expecting 4% iPhone growth and 5% growth in FY21 (those numbers have inched up in the last month). We believe this number could be closer to 10%. iPhone 6 took revenue growth from 12% to 52%.

Apple’s Ecosystem is Undervalued

We believe the Street is systematically undervaluing Apple’s ecosystem by focusing on hardware sales instead of revenue and earnings growth and optionality. This weighs heavily on Apple’s multiple, which is 17x forward earnings. We believe Apple has become a staple in about a billion people’s lives and expect over time Apple should receive more credit (in the form of a higher multiple) for the durable and sticky ecosystem it has built.

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