Apple Earnings Preview: Chinese Growth, iPhone Upgrade Program, Apple Watch In Focus

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We will be watching three key factors when Apple (NASDAQ:AAPL) publishes its Q4 FY’15 earnings on Tuesday, October 27. First, we will be looking for details on the uptake of the iPhone 6S and the new iPhone Upgrade Program, which are crucial to Apple’s long-term margin expansion. Second, we will be tracking the company’s progress in China, where economic growth has been slowing, creating a significant overhang on Apple’s stock price. Finally, we will be watching the uptake of the Apple Watch, since this will be the first full quarter of availability of the device, which also saw notable software upgrades and extended retail availability.

We have a $142 price estimate for Apple, which translates to a market cap of about $800 billion. Our price estimate is about 25% ahead of the current market price.

See Our Complete Analysis For Apple Here

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iPhone Will See Transitional Quarter, Upgrade Program In Focus

Fiscal Q4 typically represents a transitional quarter for the iPhone business. While Apple launched the latest iteration of its flagship handsets – iPhone 6S and 6S Plus – towards the end of Q4, shipping a total of 13 million units during the launch weekend, we won’t be able to gauge the full impact of the new devices on earnings since they were available for just about a week during the quarter. Earnings will still largely be driven by the iPhone 6 and, to a lesser extent, by lower-spec devices such as the iPhone 5C and 5S, which should have seen some discounting in order to drive volumes and reduce inventory prior to the launch of the new flagships. Overall, we expect moderate sequential growth in volumes and relatively stable ASPs. On a year-over-year basis, both metrics should see a meaningful jump.

There are some specific trends that we will be watching for as well. Apple has been honing its iPhone strategy to improve gross margins, as volume growth is expected to moderate going forward. For instance, the company maintained its storage mix strategy (16/64/128 GB) and it’s likely that more customers will buy the higher-tier models this time around, given the higher-resolution cameras and video recording capabilities of the new devices. The company also launched a new equipment installment scheme for the iPhone, the iPhone Upgrade program. The program helps to shorten the upgrade cycle for Apple’s most profitable product, by incentivizing customers to trade in their devices annually, while also bundling the high-margin Apple Care protection plan. (related: How The iPhone Upgrade Program Impacts Apple’s Financials) While it’s obviously early to gauge the success of the program, we be looking for specific commentary from management or proof points on how customers are taking to the program.

Will Sales Growth In  China Hold Up? 

Greater China– which includes China, Taiwan and Hong Kong – has been the biggest driver of Apple’s recent growth. Revenues from the region grew 112% year-over-year to about $13 billion during Q3 FY’15, accounting for over 55% of Apple’s consolidated growth. [1]  However, there have been concerns that the momentum could cool down, and this has created a significant overhang on Apple’s stock in recent months. GDP growth in China fell to below 7% in Q3 CY’15 and there are concerns that consumer spending could come under pressure. Moreover, the Chinese Central bank has devalued the Yuan (down by about 3% since mid-July) in response to the economic slowdown, and there’s a possibility that the trend of devaluation could continue. This may put pressure on Apple’s Chinese business, since ASPs could decline in dollar terms or volumes could take a hit if the company decides to raise prices.

Macro concerns aside, there are some specific trends in the Chinese mobile market that could benefit Apple. For one, there’s a growing penetration of high-speed mobile data services in the mainland, and this could prove a big lever for premium smartphone sales. China Mobile, the largest carrier, added a record 58 million 4G subscribers in Q3. Moreover, the Chinese smartphone market is saturating (shipments actually contracted in H1), with upgrade-driven sales accounting for a bulk of purchases. Being a high-end vendor, Apple could benefit as consumers look to upgrade to more capable devices. Separately, Apple has doubled down on its sales strategy, widening its retail footprint in the country, while prioritizing product launches in China. The company has also been bolstering its services offerings in China (such as Apple Music and movie rentals). It will be interesting to see whether these tailwinds can offset the broader economic concerns in the Chinese market.

Apple Watch Sales Should Improve On Better Supply, Software Overhaul

While the Apple Watch is unlikely to make a big difference in terms of Apple’s broader financials, we are looking at the device’s performance as a data point to gauge Apple’s ability to produce hit new products and keep its innovation engine running. We estimate that sales stood at roughly $1.3 billion in FY’Q3, with shipments of close to 2.9 million. While the initial sales missed our expectations, Apple seems to be building momentum around the product and it’s possible that we will see a better performance in FY’Q4 for a couple of reasons. Firstly, Apple was only able to reach supply-demand balance for the device in July, after it remained under-supplied through FY’Q3. Additionally, Watch sales could also be driven by availability at Apple retail stores and big box retailers such a Best Buy and Target, unlike the previous quarter when sales were primarily done online. Finally, Apple also launched new variants of the device last month, while overhauling Watch software (Watch OS2). Although Apple isn’t explicitly breaking out Watch numbers (it includes them in the Other Products segment), we should be able to estimate them based on historical growth numbers. (related: How we estimated Q3 Apple Watch Numbers)

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Notes:
  1. Apple Q3 Unaudited Summary Data []