What To Expect From Apple’s Upcoming Earnings

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Apple (NASDAQ:AAPL) is set to publish its Q1 FY 2015 earnings on January 27, reporting on what we expect to have been its strongest quarter to date. The company went into the holidays with a robust product lineup – which included its much awaited large-screen iPhone models, refreshed iPads and its Apple Pay mobile payment service. It is safe to assume that the new iPhones will be the biggest driver of quarterly earnings growth, given their higher ASPs, the easing of supply constraints and the launch in the Chinese market. Additionally, the favorable macroeconomic conditions and consumer spending growth in North America, the company’s single largest market, are also likely to have aided results. Apple has guided for revenue between $63.5 billion and $66.5 billion for the quarter, with gross margins of between 37.5% and 38.5%. In this note, we take a look at what to expect when Apple reports its numbers Tuesday.

Our $120 price estimate for Apple is slightly ahead of the current market price.

See Our Complete Analysis For Apple Here

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iPhone 6 Will Drive Earnings With ASP, Volumes Growth

Apple’s prior lack of a large-screen smartphone had been a liability of sorts, with the company losing some customers to premium Android phablets. However, with the launch of the iPhone 6 and iPhone 6 Plus, Apple has effectively filled a void in its smartphone lineup and looks set to gain significant market share in the premium smartphone market. Q1 2015 marks the first full quarter of availability for Apple’s new iPhones, and we expect the company to report solid volumes growth. Supply constraints for the device are likely to have eased with a ramp up in manufacturing, while availability has also been extended to growth markets such as China and India. We also expect a double digit year-over-year growth in iPhone ASPs due to Apple’s strategy of offering better value on higher storage (and higher margin) versions of the iPhone. While Apple has maintained its usual 16 GB capacity for the base version of the iPhone 6, which retails for $649 (off contract), it has bumped up storage capacity on the mid and top-tier models to 64 GB ($749) and 128 GB ($849) making them more attractive to buyers. Additionally, the company’s higher priced iPhone 6 Plus is also expected to see a meaningful uptake. This should have a positive impact on the company’s margins as well, given that the incremental cost of premium iPhones is likely to be well below the ASP increase (related: iPhone 6 Plus Will Hurt iPad Sales, But That’s Not Necessarily Bad For Apple).

Expect The Mac To Do Well

Although the Mac isn’t nearly as big a driver of Apple’s valuation as the iPhone, it has emerged as one of Apple’s best performing products through early 2014, and we expect the momentum to have continued into the holiday quarter. Apple notes that Mac sales have outgrown the industry for 33 out of the last 34 quarters and there appears to be more room for growth, given that the company presently holds just about a 5% share of the global PC market. Some factors driving growth include strong product differentiation in a commoditized PC market, cross-selling to the company’s large base of iOS users and increasingly attractive pricing on lower-end models such as the MacBook Air. According to preliminary data from IDC, during the fourth quarter, Mac shipments grew by around 19% year-over-year to 5.75 million units, driven by improved pricing and higher sales in mature markets. [1]

iPad May Struggle Despite Recent Product Refresh

The iPad has been struggling of late, with shipments declining for three quarters in a row on year-over-year basis. As of Q3 2014, Apple’s global tablet market share stood at 23%, compared to 29% a year ago. [2] Although Apple recently refreshed the iPad lineup, introducing a thinner and faster version of the iPad Air, along with a slightly improved iPad Mini, we do not see these products significantly reversing the decline. Global tablet sales growth has been slowing due to an increasing preference for large-screen smartphones and the impact of this trend is likely to become more pronounced for Apple, with the introduction of the iPhone 6 Plus. Moreover, much of the growth in the tablet market is coming from developing markets such as China and India, where lower-priced tablets rule the roost. However, the enterprise market could provide a pocket for growth for the iPad. Apple and IBM (NYSE:IBM) delivered their first set of business-centric applications for iPad users towards the end Q4, following their landmark deal to work together in the enterprise computing space. The availability of the applications, coupled with IBM’s marketing prowess in the enterprise space, could provide some respite for iPad shipments going forward.

Apple Pay Faces Its First Big Test

Apple’s mobile payments service, Apple Pay, was launched in the United States in October. Although many mobile companies have tried, somewhat unsuccessfully, to make a dent in the mobile payment space, we think that Apple Pay could gain traction due to its ease of use and partnerships with key retailers and payment networks. The service appears to have gotten off to a strong start, with Apple reporting over 1 million activations in the first three days and vendors such as McDonalds and Walgreens noting that the service accounts for a bulk of their tap to pay transactions. Transactions on the service are likely to have swelled through the quarter on the back of higher holiday spending, a larger list of participating vendors and banks, and a higher installed base of compatible iPhone models. While we do not expect the service to contribute meaningfully to Apple’s current financials, it could prove important from a growth and margins perspective in the long run. In the interim, we will be interested to hear about the performance of the service during the holiday shopping season.

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Notes:
  1. PC Leaders Continue Growth And Share Gains As Market Remains Slow, According to IDC, IDC, January 2015 []
  2. Fueled by Back-to-School Promotions and US Growth, the Worldwide Tablet Market Grows 11.5% in the Third Quarter, IDC, October 2014 []