Apple Has Stellar Quarter, But Should Increasing Reliance On iPhone Be A Concern?

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Apple (NASDAQ:AAPL) posted a solid set of Q1 2015 results on January 27, handily beating market expectations on revenues and earnings. As expected, the company’s new flagship iPhones were the key driver of results, owing to robust shipments to both developed and emerging markets and higher average selling prices. However, the performance of the other major product lines was mixed. The iPad continued to be impacted by a slowing tablet market and cannibalization from the new iPhones, although the Mac saw reasonably strong growth, defying the shrinking PC market. Apple’s quarterly revenues grew by around 30% year-over-year to $74.6 billion, while net income grew by 37% to about $18 billion. [1] EPS growth came in at around 47% aided by the company’s stock repurchase program. The results could have been still stronger, if not for the appreciation of the U.S. dollar. The company’s CFO noted that revenue growth during Q1 would have been 4% higher on a constant currency basis. Below are some of the key takeaways from the company’s earnings.

Our $120 price estimate for Apple is slightly ahead of the current market price. We will be revisiting our price estimate to account for the earnings release.

See Our Complete Analysis For Apple Here

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iPhone Shines With Strong Uptake In China And Higher ASPs

Q1 FY2015 marked the first full quarter of availability of Apple’s new iPhone 6 and 6 Plus models and the results were solid. Apple shipped roughly 74.5 million iPhones for the quarter, marking a 46% year-over year increase, driven by strong sales in both emerging markets (97% growth in BRIC markets) and some developed markets (U.S. shipments grew 44%). Apple’s prior lack of a large-screen handset led to pent up demand for the iPhone 6 and 6 Plus and the company noted that both devices remained under-supplied through the quarter (supply-demand balance for both models was reached in January). Greater China is likely to have been the biggest growth driver in terms of absolute shipments , with the company noting that sales to the region had doubled year-over-year. According to research firm Canalys, Apple has taken the lead in the Chinese smartphone market for the first time in terms of units shipped, largely on the back of the large-screen and LTE trends in the Chinese market. [2] The growth is especially notable since the average selling price of Apple’s handsets are roughly double those of its nearest Chinese competitors.  Bucking the trend in the broader smartphone space, Apple actually saw iPhone ASPs for the quarter grow by around by  8% year-over-year to $687 owing to the popularity of the pricier iPhone 6 Plus and the increased value that the company is offering on higher storage capacity models. The iPhone ASP increase is also likely to have a been the key driver of Apple’s gross margins growth for the quarter. Company wide gross margins increased to 39.9% compared to 37.9% in the year-ago quarter.

Apple’s Fortunes Increasingly Tied To The iPhone

iPhone revenues as a percentage of Apple’s total revenues stood at around 69% this quarter, up from around 56% last year. Moreover, growth in iPhone revenues stood at around 57% year-over-year, while the rest of Apple’s products and services combined saw revenues shrink by 6.7% year-over-year. The iPhone’s contribution to  earnings growth is likely to be even more profound, since we estimate that margins on the device are considerably higher compared to Apple’s other hardware offerings. The increasing concentration of Apple’s revenues around a single (and maturing) product line does raise some concerns. Apple now has deals in place with most major carriers for the iPhone (new carrier adds are unlikely to be a meaningful sales driver) and prospects of a similar bump in ASP/volumes growth that the company has been witnessing with the 6/6 Plus seem unlikely to translate into a more secular long-term growth trend.

However, we believe that iPhone sales will continue to grow over the long-term, albeit at a slower pace. China is likely to prove the largest growth lever going forward, given the rapid pace of LTE adoption in the country.  China Mobile, the largest Chinese carrier, began its 4G rollout in January 2014 and saw its LTE subscriber base rise to about 90 million by the end of 2014. The number is expected to swell further, as 4G users account for just about 11% of the company’s subscriber base. Additionally, there is scope for growth in the broader global smartphone markets. Apple estimates that just a fraction (mid-teens percentage levels or less) of the installed base of iPhone users have  traded-up to its new devices, leaving significant room for upgrade-driven sales. [3] More importantly, interest from Android users (who account for a bulk of the global smartphone installed base) has also been strong; with the company noting that the current iPhone line up experienced the highest Android switch rate of any of its devices in the last three years.

iPad Continues To Struggle, Mac Does Well

The iPad continued to struggle, with shipments declining by around 18% year-over-year to 21.4 million units. ASPs for the device also fell by around 5% year-over-year to $420. While Apple recently refreshed its iPad lineup, introducing a thinner and faster version of the iPad Air, along with a slightly improved iPad Mini, the new offerings were not enough to stop the decline. Some key factors impacting iPad sales include cannibalization from the new iPhones and cheaper Macs, slowing growth in the global tablet market and the longer upgrade cycles for tablets.

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 and this could provide some respite for iPad sales going forward. On the other hand, the Mac did quite well, posting 14% year-over-year shipments growth and record quarterly revenues, defying a shrinking global PC market. Apple notes that the Mac has gained market share for 34 of the last 35 quarters. Some factors that are likely to be 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.

Apple Pay Shows Promise

While Apple Pay is unlikely to meaningfully contribute to Apple’s financials in the near term, we think the service could provide some long-term upside given its potentially high margins and growth prospects. The service, which was launched in the U.S. in October, appears to be gaining momentum with Apple noting that it accounts for more than $2 out of every $3 spent on purchases using contactless payment across the three major U.S. card networks. However, Apple still needs to do a lot of heavy lifting to build a critical mass of vendors who accept the service. At the time of launch, the service covered roughly 2.5% of all merchants who accept credit cards in the United States and the number grew slightly through the quarter as another round of retailers announced support for the service. [4] On January 27,  U.S.A Technologies – a payment solutions provider – said that it would be making Apple Pay available at around 200,000 places where everyday payments occur, including vending machines, commercial laundry machines and parking meters across the United States. Apple has also said that point-of-sale suppliers are seeing strong demand from merchants who want to install the service .

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Notes:
  1. Apple Q1 2015 Earnings Press Release []
  2. Media alert: Apple takes top spot in China for first time in smart phones, Canalys, January 2015 []
  3. Apple’s (AAPL) CEO Tim Cook on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, January 2015 []
  4. Apple Pay Is Here — and There’s Just One Big Problem, Time, September 2014 []