The Small But Significant Trends From Apple’s Earnings

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Apple (NASDAQ:AAPL) posted a solid set of fiscal fourth quarter numbers on Tuesday, beating market expectations for both revenues (up 22% year-over-year) and earnings (net income up 31%), driven by solid uptake for its large-screen iPhones and robust growth in Greater China. [1] However, the company looks set to transition into a lower-growth phase going into fiscal 2016, as the iPhone will face tougher comparisons with a record fiscal 2015. Based on the company’s guidance, Q1 2016 revenues are poised to grow by under 3% y-o-y (or about 9.5% adjusted for currency effects) at the mid-point. [2] Below we take a look at the small, but notable, financial and strategic trends that could drive Apple’s performance as it braces for slower top-line growth ahead.

We have a $144 price estimate for Apple, which translates to a market cap of about $840 billion. Our estimate is about 25% ahead of the current market price.

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Apple Is Getting People To Pay More For iPhones

Apple’s iPhone ASPs stood at $670 in Q4, marking an increase of 11% year-over-year and about 2% on a sequential basis. While the number is below the $687 ASP Apple saw during the holiday quarter (Q1), it is significant considering that the company has been contending with increasing currency headwinds, particularly in the fast-growing Chinese market. [3] While some of the improvement likely came from the launch of the iPhone 6S handsets (which were available for less than a week during the quarter), Apple is also seeing relatively strong pricing power for the iPhone 6 and 6 Plus handsets, which likely offset the negative impact of potential inventory clearing of older devices such as the iPhone 5C. Currency headwinds notwithstanding, we expect ASPs to remain strong going forward, since demand for the latest handsets is expected to be heavily skewed towards the pricier higher-storage models (64GB and 128GB).

iPhoneASP

Margin Outlook Is Strong

Apple has been tweaking its iPhone strategy to improve gross margins, as volume and revenue growth is set to moderate (we are modeling 5% iPhone shipment growth for calendar year 2016, versus 23% for CY 2015). The company has been executing well in this regard, as gross margins expanded to about 39.9% in Q4, driven by lower costs as well as better iPhone ASPs. This trend should continue going forward as well, as the uptake of the iPhone upgrade program (which helps to shorten the iPhone upgrade cycle, while bundling the high-margin AppleCare plan) gains momentum and as the company’s services business ramps up (related: How The iPhone Upgrade Program Impacts Apple’s Financials). The company has guided for margins between 39% and 40% for fiscal Q1. However, considering Apple’s track record of consistently beating the upper end of guidance, it is very possible that gross margins could exceed 40%. Moreover, it is important to note that this guidance comes despite significant currency headwinds. While Apple didn’t provide gross margin numbers adjusted for currency, it noted that its revenue guidance would have been 700 basis points higher if not for FX headwinds. [2]

Apple Gross Margins

Services Playing A Bigger Role In Revenue Stream

Services are becoming increasingly important to Apple, since they provide upside from a gross margin standpoint, in addition to helping Apple to increase switching costs around its ecosystem, ensuring that customers keep coming back for its latest devices. Service revenues are now Apple’s third largest revenue stream, bringing in about $5.1 billion in revenues this quarter, eclipsing the iPad business which brought in roughly $4.3 billion. The App store has been a big driver of growth, setting new quarterly records both in terms of transacting customers (up 18%) and overall revenues (up 25%). The company’s App Store in China – a market that has so far eluded most large U.S. internet companies – was also solid, with revenues growing 127% y-o-y. Apple also noted that its fledgling mobile payment service, Apple Pay, is seeing consistent double-digit monthly growth in transactions, driven by increasing support from businesses and banks in the U.S. as well as the roll-out in the U.K.

Apple Watch Building Momentum 

Although the Apple Watch is not likely to make a significant difference to Apple’s financials in the near term, investors look at the device’s performance as a data point to gauge Apple’s ability to produce compelling new products and keep innovation going. Apple isn’t disclosing Watch sales as of now, but we believe that the company is building momentum around the product, driven by improved supply, extended retail availability and the recent software overhaul. Apple includes Watch financials in the Other Products category, which also includes Apple TV, iPod, Beats products and Accessories. Other product sales grew from to $2.64 billion in Q3 to $3.05 billion in Q4. We estimate that Watch revenues stood at $1.3 billion in Q3, while Other revenues excluding Apple Watch stood at $1.34 billion. (related: How we estimated Q3 Apple Watch Numbers) Assuming that other revenues remained roughly flat – largely in sync with iPhone seasonality – this would imply that Watch revenues stood at about $1.7 billion for Q4, translating into sequential growth of 30% by our estimates. Assuming an ASP of $450, this would imply shipments of roughly 3.77 million for the quarter.

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Notes:
  1. Apple Earnings Press Release []
  2. Apple’s (AAPL) CEO Timothy Cook on Q4 2015 Results – Earnings Call Transcript, October 2015, Seeking Alpha [] []
  3. Q4 2015 Unaudited Summary Data, Apple []