Apple (NASDAQ:AAPL) announced its Q3 FY2012 results on July 24th, exceeding its own guidance but falling short of the market’s rather bullish estimates. Nevertheless, the quarter was the company’s third best in its history, coming on the back of two of its best quarters ever. Revenues from iPhone sales were up 22% y-o-y but declined almost 30% sequentially due to softness in demand for the higher-margin iPhone 4S as well as seasonality in China following the very successful launch of the same last quarter. iPad sales surprised on the positive, with unit sales exceeding 17 million and besting the previous record of 15 million in Q4 2011. However, a deteriorating product mix took a toll on gross margins which fell by over 450 basis points sequentially.
Looking ahead, the company expects to see margins contract further in the next quarter as customers hold off on purchasing an iPhone in anticipation of the release of the iPhone 5 next quarter. However, as was seen last year, customers that held off purchasing an iPhone didn’t necessarily buy a competing product but waited until the launch of the iPhone 4S. Apple’s results last year were back-weighted with almost 40% of iPhone sales coming in Q4 CY2011 alone.
Long-term, we also see China continuing to contribute heavily to Apple’s growth and the pent-up demand for the iPhone 5, together with the holiday season, leading to an exceptionally good holiday quarter. We maintain our $700 price estimate for Apple’s stock, about 20% ahead of the current market price.
Seasonality in China mars iPhone results
While March quarter’s iPhone sales were boosted by the launch of the iPhone 4S’ on China Unicom as well as China Telecom, Apple’s sales from the Greater China region this quarter saw a sequential decline of almost $2.2 billion. Apple attributed half of this decline to “normal seasonality” in iPhone sales coming off a very successful iPhone 4S launch last quarter and the other half to inventory channel management, meaning actual sell-through was stronger. Moreover, despite a seasonal slowdown, Apple’s sales in China grew close to 50% over the same period last year.
Also, more importantly, Apple did not see a slowdown in iPhone sales attributable to the economy in China, which has shown signs of cooling off. We believe that China holds a lot of promise for Apple considering the huge 2G subscriber base that the carriers there are trying to transition to 3G (3G penetration is currently only 17% in China and growing at a good rate). A deal with China Mobile, the largest carrier in the world by subscriber base, is looking increasingly likely following Qualcomm’s recent announcement and Apple’s similar deals with the other two carriers. This deal is very important for Apple as it instantly doubles its current addressable market for the iPhone in China and can act as the next big boost to its stock, given that the iPhone accounts for more than 55% of the company’s stock value now. (see China Mobile In Talks To Offer The iPhone; Can Alone Take Apple Past $800)
The margin contraction may have come as a shock to the markets but it was mostly due to an unfavorable product mix that tilted more towards the lower-margin older products. What this means is that many customers might be holding off purchasing the higher-end iPhone 4S as rumors about the iPhone 5 circulate in the market. Apple talked about a ‘fall transition’ impacting margins in the coming quarter; so the iPhone 5 launch will most likely be scheduled towards the end of Q4 or early Q1. We expect the huge pent-up demand to help Apple more than offset the current loss of sales with a very strong holiday quarter, a la last year.
iPad’s blowout quarter
Further proof about the high pent-up demand that Apple’s products generate can be found in the company’s iPad sales this quarter. After a rather muted last quarter, Apple sold about 44% more iPads sequentially and broke previous iPad records as it fulfilled the huge demand of customers that had held off purchasing an iPad last quarter. One of the main reasons why we estimate full year sales is that the q-o-q noise is eliminated in our forecasts.
At our current estimates, the iPad contributes less than 12% to Apple’s value but a rapid expansion of the tablet market together with margin improvement due to falling component costs can lead to a bigger iPad contribution. Going forward, we see the iPad performing well in the absence of meaningful competitors in the tablet market and the very nascent stage that the market is in. However, a very potent threat in the form of Microsoft’s Windows 8 looms on the horizon.
Microsoft plans to launch Windows 8, which will be made available on both PCs and tablets, later this year. A lot of PC as well as smartphone manufacturers are expected to jump in on the offering to tap the nascent tablet market. Microsoft has a widely installed PC base in place that it can leverage to pose a big threat in the young market. Moreover, it can also leverage its partnership with Nokia to push for an integrated experience across all devices, mobile or PCs, in order to create a viable third ecosystem.