Apple Earnings Preview: iPhone Could Benefit From LTE In China; Watching For Rebound In iPad Sales

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Apple (NASDAQ:AAPL) is slated to release its FY Q3 2014 earnings on July 22 after the markets close. The previous quarter turned out to be a strong one for the company, with revenues growing by around 5% year-over-year to $45.6 billion and net income rising by around 7%  to about $10.2 billion, driven by a strong performance from the iPhone, which sold well across geographies and price ranges. [1] We largely expect the strong iPhone momentum to continue through this quarter driven by emerging markets, particularly China, where China Mobile’s (NYSE:CHL) LTE network expansion could translate to better uptake for high-end handsets. However, we believe that the company’s other two key product lines – the iPad and the Mac – could see some sluggishness. The company has guided for quarterly revenues of between $36 billion and $38 billion and gross margins of between 37%and 38%. Overall, we expect the company to meet its revenue guidance while possibly meeting the high end or even exceeding its gross margin guidance. EPS could also see a meaningful jump due to the company’s aggressive share repurchases over the last three quarters. Below is a brief look at some of the trends that could influence results.

Trefis has a $94 price estimate for Apple, which is about in line with the current market price.

See our complete analysis for Apple stock here

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China Mobile LTE Adoption To Drive iPhone Sales

Apple has been looking to ride the growth wave in the Chinese market, signing a deal to sell the iPhone to customers of China Mobile, the world’s largest mobile carrier. Apple’s Q2 sales in China rose by around 13% year-over-year, owing largely to the China Mobile agreement, and we believe that sales could accelerate further this quarter. The iPhone’s official launch on China Mobile coincided with the beginning of the carrier’s 4G LTE rollout. Although the 4G expansion is still in the early stages, the adoption has been encouraging thus far. China Mobile’s 4G subscriber base, which was nonexistent in January, grew to about 4.8 million in April and then ballooned to around 8.1 million by the end of May. This could prove positive for high-end handset manufacturers, as several users are likely to have upgraded to 4G handsets. Apple in particular stands to benefit, considering that it dominates the high-end of the Chinese market, with about 80% of handsets sold in the $500+ price range being iPhones. [2] Apple could also benefit from the fact that chief rival Samsung has been stuck with excess stocks of 3G phones in China. [3] Apple’s overall iPhone channel inventory remained at around 15.4 million units last quarter, which is in line with the company’s target of 4 to 6 weeks worth of inventory.

iPad Sales Could Rebound, Albeit Slightly

Although the iPad isn’t nearly as big a driver of Apple’s valuation as the iPhone, it accounts for about 11% of the company’s stock price according to our estimates, and remains an important component of the company’s ecosystem. There have been signs of a slowdown in the tablet market. As of Q1 2014, global tablet shipments grew by just about 3.9% and IDC forecasts that tablet shipments for the year will rise by about 12.1% , compared to a growth rate of around 51.8% during 2013. Apple’s tablet market share declined by around 8% year-over-year. In terms of shipments, FY Q2 2014 iPad sell-ins fell by around 16% year-over-year to about 16.3 million units due to a smaller need for channel inventory replenishments. Meanwhile, sell-through rates, which are a better indicator of end market demand, also declined by around 3%. However, the company seems to be viewing this as minor turbulence, rather than a longer term trend, with CEO Tim Cook indicating that he was bullish on the device’s future. [4] Overall, we believe that the iPad could see growth rates that are slightly below the market growth rate for this quarter, given that a significant portion of the tablet volumes for this year are likely to come from cheaper Android powered devices.

Mac Sales Could Get A Boost From China, But U.S. Likely To Be Sluggish

Apple’s Mac business saw some growth over the last quarter, with shipments rising to around 4.1 million units compared to about 3.95 million units during the same quarter a year ago. This was primarily attributable to strong performance from the MacBook Pro and MacBook Air models, which have allowed the company to gain global market share for 31 of the last 32 quarters. The Mac’s performance for this quarter is likely to be influenced by lower business in the United States, where IDC’s preliminary report showed Mac shipments falling by around 2%. [5] This comes despite the fact that many other large personal computer vendors have actually seen their shipments grow as businesses users replace legacy PCs running Windows XP, which is no longer supported by Microsoft (NASDAQ:MSFT). However, China could prove to be a bright spot. Mac shipments grew at a rate of around 13% during FY Q2 in China, despite the fact that the Chinese PC market is forecast to decline by around 8%. [4]

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Notes:
  1. Apple Reports Second Quarter Results, Apple, April 2014 []
  2. Of the 27% of Chinese phones that cost >$500, 80% are Apples, Fortune, March 2014 []
  3. Samsung Press Release, Samsung, July 2014 []
  4. Apple’s CEO Discusses F2Q 2014 Results – Earnings Call Transcript, Seeking Alpha, April 2014 [] []
  5. Mac sales continue to slide in Q2 as overall PC market rebounds, Appleinsider, July 2014 []