Wall Street relieved by Apple’s strong guidance for holiday quarter

28 Oct 2015 | Author: | No comments yet »

Apple Sells 48 Million iPhones, as Strong Growth in China Helps It Beat Wall Street Forecasts.

Apple turned in another stellar quarter, driven by a 22% year-over-year jump in sales of its flagship iPhone line with particular strength in China, as it beat analyst expectations. The company, which began shipping the new iPhone 6s and 6s Plus in late September, reported a record $51.5 billion in sales (up 22%) with net profit increasing 31%, to $11.1 billion ($1.96 per share) for its fiscal 2015 fourth quarter ended Sept. 26. And despite reassuring words from CEO Tim Cook that all was well, there were still plenty of doubters leading up to Apple’s Q4 earnings release yesterday.

While Apple’s AAPL 2.63% September-quarter results did not blow out Street expectations, they were nevertheless solid, with moderate upside to our and consensus estimates, and were good enough to remain bullish on the story. Apple’s international sales represented 62% of revenue in the quarter, and the company said sales in the China market nearly doubled — to $12.5 billion — with iPhone sales in the region up 87% year over year.

With Cook & Co. forecasting year-over-year iPhone unit growth off Herculean comps in the December quarter with China remaining white hot, we believe last night was a major step in turning the positive tide around the Apple story. While there will continue to be worries around FY16 growth during this 6s product cycle as the “iPhone 6 hangover” thesis remains a lingering cloud over Cupertino’s head, we believe this quarter and guidance proves yet again how much fuel is left in the iPhone engine. Cook, who just returned from a trip to Hangzhou and Beijing to announce plans to bring renewable energy to its supply chain, could not have been more effusive about the company’s prospects there. No company wants to be that dependent on a single product line, however, and Apple clearly needs to find more big revenue streams to keep the iPhone revenue share percentage from continuing to grow higher.

During the call with analysts yesterday, Cook acknowledged some of the broader macroeconomic concerns, but said they didn’t jibe with what he saw on the ground. “If I were to shut off my web and shut off the TV and just look how many customers are coming in our stores regardless to whether they’re buying, how many people are coming online, and in addition, looking at our sales trend, I wouldn’t know if there was any economic issue at all in China,” Cook said. “I also visited our retail stores in China, which were among the busiest in the world.” Cook also pointed to the long-term opportunity in China, which he considers to be massive. We want to provide the same innovation in the living room that we delivered in our iOS devices.” Sales of iPads were down 20% in the most recent quarter, to 9.9 million units versus 12.3 million in the year-earlier period. He cited one study saying China’s middle class numbered 50 million just five years ago, but is expected to be 10 times that size by 2020. “We’re very bullish on it, and I would point out that we’re investing in China not for next or the quarter after, or the quarter after,” Cook said. “We’re investing for the decades ahead and as we look at it, our own view is that China will be Apple’s top market in the world. Plus, though the company is optimistic about its iPhone growth potential on both a unit and revenue basis next quarter — as Cook said in their earnings call — everyone knows that all great runs have to come to an end at some point.

While headline guidance was down the middle of the fairway, CQ4 iPhone units still look to be a little better (78-79MM) when adjusting for AAPL’s recent history of beats on both revs/EPS. The company does not break out sales of Apple TV, Apple Watch or Beats music accessories, which are lumped together in the “other products” segment; sales for that category rose 61% to $3.0 billion. More importantly, we feel good about our downgrade off last Q’s earnings as “beat/raise” has broadly given way to more of a “holding pattern” while new products/services gestate. I was very impressed with the number of developers I met last week, and, of course, the customers in stores are enthusiastically contagious.” Cook said that more than 50 percent of people in China who bought the iPhone 6 and 6s were buying their very first iPhone. In fact, the worldwide smartphone business continues to slow — even growth areas like China have started to stagnate — so that impact is bound to eventually impact all players in the smartphone market, including Apple.

One potential way to address those markets, as well as the large percentage of consumers in more established markets where Apple’s prices also present an impediment to growth, was actually discussed by Cook on Tuesday’s call. Apple is expecting that both their and several carriers’ new trade-in and annual upgrade policies should eventually lead to an abundance of “barely used” iPhones that could then be sold at lower price points to more cost-sensitive customers.

While the company has announced its annual iPhone upgrade policy, so have all the major carriers here in the U.S., and we’ll likely see similar policies from other carriers around the world. Over the past week, the commentary from U.S. operators about declining phone upgrade rates was starting to concern us, but apparently China continues to chug along unabated, with mainland units growing 120% during the quarter.

At first glance, however, it seems like it could blunt the immediate impact of these sales, thought it might also smooth out some iPhone revenue longer term. As we learn more about phone upgrade programs, we agree with management’s assessment that the benefit might actually be larger in future years than what they are seeing now. On the positive side, if Apple can continue to build the base of iPhone users, it can generate more services and other income from things like the App Store, Apple Music, etc.

On top of this, early reports from carriers suggest that only a small fraction of their customer base is actually starting to take advantage of these trade-ins. New operating systems, new versions of applications, only partially-transferred settings, and other real-world issues make it less appealing to upgrade than the theory sometimes sounds. Given how much information we store on these devices and how important they’ve become, any glitches with smartphone upgrades can create a very negative experience for customers. As with other smart devices, the lifetimes of smartphones continue to increase, particularly as we get to really high-quality devices with large screens. The need to upgrade just isn’t as compelling as it used to be and that could prove to have a large negative impact on the potential size of the “barely used” phone market.

But, there do seem to be signs that even though competitors haven’t been able to bring it down, Apple’s own challenges could be the hardest to overcome. With high retention rates, a superior ecosystem, and multi-product compute advantage, we believe such elevated level of earnings and FCF of around $60bn per annum should be sustainable long term.

We expect users from other computing platforms to continue to switch over, as iOS offers ever growing ecosystem advantages and superior user experience. Taking the company’s FQ1 revenue guidance of $75.5-$77.5B and assuming that iPad and iPod units continue to decline aggressively, we estimate that AAPL will ship 79.5M iPhones in FQ1, up 7% Y/Y. That said, we believe the next true elongated stock “move” will be determined by what CY16 iPhone ships can look like, and the Street likely won’t have a view on that until April when AAPL reports the Mar Q. Reassuringly Q1 guidance bracketed consensus, and though it will likely not fully put to rest the bear case that Apple will face declines in FY16, it makes the risk-reward increasingly compelling in our view given a low valuation, continued secular growth in China and the potential for the iPhone 7 cycle to reaccelerate growth.

While concern over slowing/negative iPhone growth is likely to remain a topic of much debate (e.g., focus on inventory replenishment vs. sell-thru now in focus for F1Q16), we believe Apple’s results and outlook should be viewed positively—especially with Apple shares trading at ~8.3x ex-cash on our F2017 EPS estimate. While tough Y/Y iPhone compares still could make for an air pocket or two in 1H C2016, we are modestly lifting our growth estimates due to 1) sturdy ASPs, 2) accelerating converts, 3) potential of shortening replacement cycles with the advent of upgrade programs, and 4) more favorable mix due to increasing effects of services. We think there are several tailwinds that should benefit AAPL across both revenues and EPS – 1) ~1/3 of the install base has migrated to the 6 product line, 2) Android switch rate at 30% suggests further gains likely, 3) tailwinds in China from LTE expansion and further uptake of AAPL products, 4) ASP’s should sustainably ramp higher given memory uptake and 5) gross-margins could see upside given leverage and cycle efficiency. Robert Cihra, Sterne Agee: Buy AAPL stock and not its supply-chain, as we believe investor fears about iPhone comps continue to offer compelling 40% upside… Ironically, it wasn’t too long ago that bears cited China as a risk for Apple, where its high-priced products were apparently never going to sell.

Maynard Um, Wells Fargo: The Good. 1) iPhone sales of $32.2B exceed our $31.6B (Street $31.4B) on stronger ASPs of $670 (our/Street: $645/$649), 2) iPhone channel inventory was below target range, which should help the Dec/Mar quarters, 3) iPad channel inventory also fell below target range, 4) Gross margin of 39.9% was above our/Street’s 39.7%/39.3%, 5) Watch units increased sequentially, 6) FQ4 EPS of $1.96 was above our/Street’s $1.95/$1.88, 7) implied F16 EPS of $3.08-$3.29 vs. our $3.15 and Street’s $3.22. Revenues were slightly ahead while EPS benefited from better margins. iPhone shipments were inline with estimates of 48mm but ASP of $670 was significantly higher. Although the company continues to perform well, we think stock performance remains tied to iPhone shipments, which face tough compares over the next couple of quarters making it difficult for the stock to work. While analysts were trying to get clues from Cook in terms of iPhone unit sales growth through 2016, these new upgrade programs represent one of the more important long-term sales trends for iPhone. We mention this in the context that Apple has been depleting its domestic cash balance by aggressively returning cash to shareholders, completing over $143 billion of its $200 billion plan, including repurchasing 122 million shares of stock worth $14 billion in the September quarter.

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