Apple Earnings: Analyzing iPhone Performance And Estimating Q3 Watch Numbers

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Apple‘s (NASDAQ:AAPL) Q3 FY’15 numbers beat market expectations on both earnings and revenues, driven by robust demand for the iPhone (59% year-over-year revenue growth), strong sales in Greater China (112% growth) and higher Mac sales (9% growth).  ((Q3 2015 Unaudited Summary Data, Apple, July 2015)) The Apple Watch, which was launched earlier in the quarter, appears to be off to a somewhat slow start. While Apple remained tight-lipped about Watch numbers, we estimate that it shipped close to 2.9 million units (which we discuss further below). Quarterly revenues grew by about 33% year-over-year to $49.6 billion, while gross margins came in at 39.7% versus to 39.4% in the year-ago quarter. ((Apple Reports Record Third Quarter Results, Apple, July 2015)) The company’s cash position (including marketable securities) swelled to $202.8 billion, marking a $9.3 billion sequential increase. However, despite the earnings beat, Apple’s stock fell by about 7% in after hours trading as iPhone shipments apparently missed analyst estimates and its Q4 FY’15 guidance was below market expectations. 

Overall, we thought the results were solid, considering the unfavourable FX environment and Apple’s decision to tighten channel inventory. Apple now derives more than 60% of its revenues from overseas and the strong U.S. dollar has resulted in some headwinds for volumes and price realizations. Apple noted that y-o-y sales growth would have been 800 basis points higher on a currency neutral basis. Separately, the company also reduced channel inventory by over 1 million units across product lines (600k for iPhone), meaning that its sell-throughs to end customers were actually better than the shipment numbers recognized in revenues. In this note, we will focus on the performance and outlook for the iPhone and our expectations for the Apple Watch during Q3.

We have a $143 price estimate for Apple, which translates to a market cap of about $830 billion. Our estimate is over 15% ahead of the current market price.

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See Our Complete Analysis For Apple Here

iPhone Sees Strong Uptake In China, Sequentially Stable ASP

The iPhone had another solid quarter, driven by demand for the 6 and 6 Plus models, with shipments soaring by about 35% year-over-year to about 47.5 million units. The shipment growth rate stands at about 3x that of the broader smartphone market. Greater China continued to be the biggest growth driver for the iPhone, with shipments to the region growing by about 87% year over year.  This is particularly impressive given that IDC estimated a growth rate of just about 5% for the smartphone market in Greater China. The device also continues to do well in other markets; iPhone sales also more than doubled in Germany, Korea, Malaysia, and Vietnam, while sales in India grew by more than 93%. [1]

As expected, average selling prices jumped by 17.5% year-over-year to about $660 owing to the new storage mix strategy and the higher priced 6 Plus. The numbers remained flat on a sequential basis, and this is quite encouraging in our view, given that Apple often sees a drop in FY’Q3 vs. FYQ2 iPhone ASP numbers, as the device moves towards the end of its product life cycle. This could indicate that Apple’s pricing power with the iPhone 6 remains stronger than with previous models.

 The iPhone accounts for roughly 60% of Apple’s value by our estimates, and iPhone shipments and ASPs remain Apple’s biggest valuation driver. While the massive volume growth that Apple has seen with the iPhone 6 models has been driven primarily by pent-up demand and advanced upgrade cycles for the big screens that Apple previously lacked, we believe the future outlook is also promising. For instance, Apple says that it has been seeing its highest switch rate from Android, and also notes that just 27% of its installed base of customers prior to the launch of 6 and 6 Plus have upgraded, leaving plenty of room for growth. Loyalty rates for the iPhone also remain high, with 86% of iPhone users intending to purchase a new phone indicating that they would buy another iPhone. Moreover, Apple still appears very bullish about the iPhone’s prospects. The company is reported to have asked its manufacturing partners to prepare for an initial production run in the range of 85 million to 90 million units for its next-generation iPhone (expected to be unveiled in September) by December  31. ((Apple’s Early iPhone Call, WSJ, July, 2015)) This would be a 15%+ improvement (midpoint) from the 70 million to 80 million unit initial order that was placed for the iPhone 6.

Apple Watch Has A Slow Start, But Momentum Is Growing 

Although the Apple Watch is unlikely to make a big difference in terms of Apple’s broader financials, investors and analysts are likely to look at the device’s performance as an important data point to gauge Apple’s ability to produce hit new products and keep its innovation engine running. The product also has a symbolic importance, being the company’s first new product category in the Tim Cook era. While Apple isn’t breaking out Watch numbers (it includes them in the Other Products segment), we estimate that sales stood at roughly $1.3 billion in FY’Q3, with shipments of close to 2.9 million. Although these numbers are below our initial projections, we have a few reasons to believe that sales will pick up going forward. Firstly, customer satisfaction scores for the device have been positive, with market research firm Wristly measuring a 97% customer satisfaction rate. Secondly, Apple was only able to reach supply-demand balance for the device this month, after it remained under-supplied through FY’Q3. Additionally, Watch sales could also be driven by in-store and extended international availability, holiday demand, the forthcoming software overhaul (Watch OS2) and greater developer support. Moreover, Apple says that June sales for the Watch exceeded April and May sales, indicating the company clearly is building momentum around the product. With that said, we are revising our Watch shipments estimate for CY2015 downward to 11 million units from a previous estimate of 17.5 million.

Here’s how we estimated Watch numbers using Apple’s Other Product revenues: first, we use sequential numbers rather than year-over-year numbers, since quarterly figures for FY’15 include the results for Beats Electronics, which Apple acquired in mid-2014. Other Product revenues have grown from $1.689 billion in Q2 FY’15  (when they included just iPod and Accessories) to about $2.641 billion in Q3 FY’15  (iPod, Accessories and Watch). However it should be noted that the Watch has accounted for more than 100% of this growth, since both iPod and Accessory revenues saw a sequential decline. Although Apple stopped breaking out iPod and Accessories revenues in FY’14, based on historical trends, we estimate that iPod sales for Q2 FY’15 stood at roughly $323 million (a 30% year-over-year decline), which implies that Accessory sales stood at $1,366 million. Now, assuming that iPod revenues declined by about 10% sequentially in Q3 and Accessories revenues fell by 23% (assuming it’s roughly in sync with iPhone seasonality) this would mean that iPod and Accessory revenues combined stood at about $1.34 billion. This would imply that Watch sales came in at roughly $1.3 billion. Assuming an ASP of $450, this translates to shipments of roughly 2.88 million units for the quarter. We have reason to believe that our estimates are in the right ballpark, since Apple noted that Watch sales outpaced initial sales of the iPhone and iPad during the first nine weeks after their launch. For reference, Apple sold 2 million iPads over the first 60 days of launch. ((Strong iPhone sales; Apple stock down with few Watch details, AP, July 2015))

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Notes:
  1. Apple’s (AAPL) CEO Tim Cook on Q3 2015 Results – Earnings Call Transcript, Seeking Alpha, July 2015 []