Apple (NASDAQ:AAPL) announced its Q4 FY2012 results on October 25th, exceeding its own guidance on both the revenues and margins front. The company reported its third best quarter ever as iPhone 5 availability in the last few days of the quarter more than made up for the seasonal slowdown ahead of the launch. Revenues from iPhone sales were up 5% sequentially and more than 55% y-o-y. Gross margins declined both sequentially and y-o-y, but it was about 150 basis points better than guidance as commodity costs declined and sales mix was better than anticipated. Surprisingly, however, the company posted an 18% sequential decline in iPad sales despite realizing a full quarter of new iPad sales in China.
Looking ahead, the company expects to see margins contract further in the next quarter as it looks to launch a number of lower margin new products ahead of the holiday season in what is going to be the broadest product refresh cycle in its history. While margins may be compressed, the launch of the iPad mini next week and the pent-up demand for the iPhone 5 could make this holiday quarter its best ever. Longer term, we also see China contributing heavily to Apple’s growth both in terms of iPhone as well as iPad sales. We maintain our $700 price estimate for Apple’s stock, about 15% ahead of the current market price.
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China supports iPhone growth story
At close to 55% of Apple’s value, the iPhone is the single most important product for the company. The iPhone’s global mobile phone market share has steadily increased from zero at the start of 2007 to around 5.4% in 2011. As a result, Apple’s iPhone unit sales have been growing at an average annual rate of about 90% every year. This year, however, we estimate iPhone sales to grow at less than 45% for the full year despite accounting for what we think will be an exceptional holiday quarter in Q4.
With the smartphone market in developed regions such as the U.S. saturating (U.S. smartphone sales grew y-o-y by just 9% in Q2), Apple will be looking to tap the fast-growing emerging markets such as China to grow at historical rates. China, despite being only in the early stages of smartphone adoption, has already pulled ahead of the U.S. as the world’s largest smartphone market by volume. This is an incredible statistic given that 3G penetration in China stands at only about 18% currently. Considering the huge 2G subscriber base that the Chinese carriers are looking to upgrade to 3G, the potential for Apple to ride the boom is huge.
This is also borne out by the rapid pace at which Apple’s revenues from China are growing. Revenues from greater China, which includes mainland China, Hong Kong and Taiwan, in the September quarter grew 26% year-over-year and accounted for 15% of Apple’s revenues for the fiscal year. This brought Apple’s FY2012 revenues from the region to about $24 billion, a growth of about 80% over FY 2011.
iPad demand remains strong despite surprise
As the country grows and the average Chinese buyer sees an increase in buying power, we expect to see a growing shift in demand from 2G to 3G smartphones. The iPhone can help Apple tap this phenomenal growth in demand. Currently, the iPhone is available on only China Unicom and China Telecom, the smaller two of the only three Chinese wireless carriers. A deal with the remaining carrier, China Mobile, which is not only the biggest carrier in China but also globally with about 700 million subscribers, could almost double Apple’s addressable market in China. But it seems Apple might have to foot a part of the subsidy bill and take a hit on margins for such a contract to happen.
iPad saw a sequential decline of 18% in revenues and units on the back of what was a record quarter in Q2 due to the new iPad launch. This was 26% higher in terms of units and 9% higher in terms of sales versus a year ago. Apple CEO Tim Cook said that this was because of the high inventory level leading into Q3 as suppliers stocked up on the iPad in a quarter of intense demand. That however caused sell-in numbers to skew lower in Q3, despite strong sell-through demand. Apple said that sell-through iPad unit sales rose 44% y-o-y despite an 18% decline in sell-in numbers.
At our current estimates, the iPad contributes about 13% 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 newly launched iPad mini helping Apple defend its tablet share better in the face of increasing competition from the low-end of the tablet market. However, lower margins on the iPad mini mean that Apple will need to move more units of the smaller tablet to offset the impact of cannibalization of its higher-margin tablets.
In the higher-margin arena, Apple faces a very potent threat in the form of Microsoft’s Windows 8 platform. Microsoft’s recently launched Windows 8, which is being made available on both PCs and tablets, will see a lot of PC as well as smartphone manufacturers jump in to tap the nascent tablet market. Microsoft has a widely installed PC base in place that it can leverage to incentivize app development and pose a big threat in the young market. Moreover, it can also leverage its Windows Phone partnership with Nokia to push for an integrated experience across all devices, mobile or PCs, in order to create a viable third ecosystem.