China and iPhone ASPs Trigger December Miss; The Healing Process Begins
Apple reissued lower guidance for the Dec-18 quarter (8% below Street expectations), citing soft iPhone sales in China as the primary driver of lower-than-expected revenue. Despite what will be a more complicated 2019 for the company, we believe the fundamentals are unchanged and we continue to expect AAPL to outperform the rest of FAANG this year. Here are our key takeaways:
- China: 2/3 of the issue. Macroeconomic conditions including a slowing Chinese economy, a strong US dollar, and trade tensions that create uncertainty, weighed on iPhone demand in China. Greater China represents about 15% of Apple’s revenue
- Price increase dampens iPhone upgrades: 1/3 of the issue. In Apple’s FY18, the iPhone average selling price rose 23%, and we saw that iPhone demand was not as price-elastic as Apple imagined. The price hike did not take. New data from the Dec-18 quarter likely removes upside related to pricing over the next 12 months.
- While this is slightly different than the company’s rationale spelled out in a letter to investors, which attributed the miss mostly to iPhone sales in China, it doesn’t change the timing of the road to recovery. The implication of price-inelastic iPhone demand is that the iPhone’s weighted average selling price is more likely to decrease in the Sept-19 quarter than increase.
Apple as a Service Theme Still Intact
This challenging quarter accelerates the change in mindset from iPhone product cycles to Apple as a Service. Despite disappointing December results and less upside to future iPhone ASPs, we believe the Apple as a Service theme is intact. We don’t see any sustainable shifts in market share, so iPhone owners will remain in the ecosystem, and eventually upgrade (the point of Apple as a Service). Other revenue segments were up 19% y/y, a clear indication that the health of the business as a whole is not entirely dependent on iPhone sales.
Rebuilding Investor Confidence
We believe the in first step healing investor confidence related to Apple’s long-term potential is related to Mar-19 guidance. While the company reissued Dec-18 guidance, they did not provide a Mar-19 outlook. We believe investor confidence will begin to rebuild only if Mar-19 revenue guidance implies a midpoint of revenue growth better than the -5% y/y that will likely be reported in Dec-18. We generally expect Apple to issue Mar-18 guidance for revenue growth of -5% y/y, similar to the decline the company now expects in the Dec-18 quarter. As a result, it may not be until Apple guides for Jun-19 (likely the last week in April) that investor confidence begins to rebound.
Bright Spots in the Quarter
It’s important to recognize that the preliminary comments on Dec-18 results had some positive data points as well. The Apple ecosystem appears to be strong. All other segments are thriving on top of a strong iPhone user base: Services, Mac, iPad, and wearables (Apple Watch, AirPods) grew a combined 19% y/y. This is the key to the Apple as a Service thesis and suggests that the business as a whole can grow on top of a large, stable user base, even if the base is not expanding as fast as it has in the past.
Tim Cook is at the top of his game. This may sound counterintuitive, given the negative Dec-18 results, but tough quarters will come and the team needs to rise to the occasion. Cook’s commentary on investor expectations, Apple’s talent, and its ability to innovate are spot on—a battle cry for the company and a sign of strong leadership. We don’t want to let them off the hook for bad forecasting, but there are more important things than quarterly forecasts, and Cook has his priorities straight.
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