How Apple Continues To Post Robust Margins Despite Slowing Sales, Currency Headwinds

+2.57%
Upside
174
Market
178
Trefis
AAPL: Apple logo
AAPL
Apple

Apple (NASDAQ:AAPL) posted a mixed set of Q1 FY 2016 earnings amid economic softness in China, a tepid uptake for its latest iPhone 6S and FX headwinds. iPhone shipments grew by just 0.4% year-over-year, marking the weakest sales growth since the device’s launch, and Apple expects shipments to actually decline during the Q2. Apple’s other products didn’t fare too well either, with iPad shipments dropping 25% and shipments of the Mac, which has been a recent source of growth, dropping by about 3%. While the quarterly numbers could signal the end of an era of super-growth for Apple, investors should find some comfort in the fact that the company’s margin focus remain largely intact. Apple’s gross margins were up slightly to 40.1% (39.7% adjusted for revenue from patent infringement settlement), while net profits grew by 2%, despite significant currency headwinds – revenue growth would have been 6% higher if not for currency effects. In this note, we take a look at how Apple is managing its margins despite the industry and macro weakness.

We have a $144 price estimate for Apple, which is significantly ahead of the current market price. We will be updating our valuation model to account for the earnings.

See Our Complete Analysis For Apple Here

Relevant Articles
  1. Down 10% This Year, Will Gen AI Tools Help Apple Stock Recover?
  2. Down 5% Over The Last Month, Will Strong iPhone Sales Help Apple Offset Mac Headwinds In Q1?
  3. After Over A 40% Rally In 2023, Will Antitrust And iPhone Issues Hurt Apple Stock?
  4. Up 45% Since The Beginning Of 2023, Where Is Apple Stock Headed?
  5. Up 34% This Year, Will Apple Stock Rally Further Following Q4 Results?
  6. Will New iPhones Help Apple Stock Offset A China Slump?

Customers Are Paying More Per Device

iPhone pricing is a big lever of Apple’s profitability. iPhone ASPs rose from $687 to $691, likely driven by a higher mix of iPhone Plus models and an increasing preference for higher storage tiers. The improvement is noteworthy on two counts. Firstly, the growth comes despite currency headwinds, and Apple says that ASPs would have been $740 in constant currency terms. Secondly, growth in the global smartphone market has slowed significantly and most smartphone manufacturers are actually seeing prices contract. For instance, Samsung’s ASPs fell to under $190 in Q3 CY’15. Pricing for Apple’s other product categories was also encouraging. iPad ASPs increased by $20 year-over-year to $439, likely driven by a lower mix of the iPad Mini, which is being cannibalized by the larger iPhones as well as due to the introduction of the large-form factor iPad Pro. [1] The Mac also saw a slight bump in average selling prices. While the across-the-board improvement in pricing indicates that Apple’s brand cachet and pricing power are holding up despite industry headwinds, the company may need to play the pricing card to drive future growth.

Increasing Mix Of Services

Apple’s service revenues stood at $5.5 billion for the quarter, marking a 15% increase over last year, driven primarily by higher sales from the App store. Besides providing healthy gross margins, services help Apple increase switching costs around its ecosystem, ensuring that customers keep coming back for its latest devices. Revenues from apps increased by 27% while the number of transacting customers on the App store grew 18%. Apple Pay also saw accelerated usage driven by increasing support from businesses and banks in the U.S and entry into new markets (Canada, Australia). Apple said that usage of the service has accelerated, with the growth rate during the second half of 2015 being 10x higher than in the first half of the year. ((Apple’s (AAPL) CEO Tim Cook on Q1 2016 Results – Earnings Call Transcript, Seeking Alpha, January 2016)) Apple Music notched a total of 10 million paying subscribers in the four months since customers began paying for the service. Interestingly, Apple is now disclosing its active device installed base – 1 billion, up 25% year-over-year – as it potentially looks to persuade investors that it should garner a valuation premium for its services segment like many of its internet rivals do. The company defines an active device as one that has been engaged with its services within the past 90 days. 

Potentially Better Leverage With Suppliers

Apple does a bulk of its device manufacturing via contract manufacturers in Greater China and sources several electronic components from the far East, and there could be some cost benefits stemming from the devaluation of Asian currencies. Although Apple likely works with its vendors in dollar terms, it should have some bargaining power with suppliers who may see lower dollar costs. Additionally, the slowing – or negative – growth in major consumer electronics categories (tablets, PCs, smartphones) could give Apple some leverage in its negotiation with vendors. That said, any potential currency tailwinds on the cost front are unlikely to offset the revenue loss stemming from currency movements.

View Interactive Institutional Research (Powered by Trefis):

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Apple Q1 2016 Unaudited Summary Data []