Takeaways From Apple’s Earnings Miss

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Apple (NASDAQ:AAPL) published its Q2 FY’16 earnings on Tuesday, posting a larger than expected decline in revenues and earnings, amid falling iPhone shipments (down 16% year-over-year), weak sales in greater China (down 26%), currency headwinds and a tough comparison with Q2 FY’15. The outlook for Q3 also remains lackluster, with the company guiding for declines in both sales and gross margins. Below we provide some of the key takeaways from the company’s earnings release and what they could mean for Apple going forward. [1]

We have a $135 price estimate for Apple, which is about 30% ahead of the current market price. We will be updating our model and price estimate to account for the recent earnings.

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Key Financials And Outlook

AAPL_Q2_1

  • The strong U.S. dollar weighed on the top line, with the firm indicating that its revenue decline would have been about 9%, or 400 basis points less than the reported decline in constant currency terms.
  • While gross margins came in at the upper end of the company’s projections, it still marks a departure from Apple’s track record of relatively consistently beating margins guidance.
  • Guidance for fiscal Q3 also came in below expectations, driven likely by macro headwinds and an aging iPhone 6 series lineup (a refresh is due this fall) which could prompt customers to hold off on upgrades.

iPhone Performance

AAPL_Q2_2

  • iPhone shipments were weighed down by sluggish uptake for the 6S, a tough comparison with Q2’15 when the company benefited from soaring demand for its just launched large-screen iPhone and mounting competition from the likes of Samsung – which launched its well-received Galaxy S7 handsets during the quarter. While the outlook remains tough, the launch of the iPhone 7, due in fiscal Q4, could prove a key near-term catalyst for the iPhone business.
  • Although iPhone ASPs dropped year-over-year, the relatively small magnitude of the decline was encouraging (-3%), given that Apple faced meaningful currency headwinds over the quarter. This indicates that Apple is maintaining pricing power for its devices. That said, ASPs should decline in Q3, as the $399 iPhone SE – which was launched towards the end of Q2 – contributes to the revenue mix, while the iPhone 6S potentially sees discounts as it moves toward the end of its product life-cycle.

AAPL_Q2_3

iPad & Mac 

  • The Mac had another mixed quarter, driven primarily by headwinds in the global PC market. Research firm Gartner estimates that worldwide PC shipments fell 9.6% in Q1 2016. [2] That said, Apple could launch an updated MacBook Pro line-up in Q3, stimulating sales.
  • iPad sales continued their descent, driven by longer upgrade cycles for tablets and increasing cannibalization from large-screen smartphones. However, Apple expects to post its best levels of iPad revenues growth in over two years during Q2, likely driven by the new iPad Pro devices which sport premium price tags.

Services & Watch 

  • Services now constitute Apple’s second largest business segment after iPhone. Service revenues grew 20% y-o-y, driven by higher App Store sales (+35%) and a reasonably strong uptake for the Apple Music streaming service (13 million paying subscribers, up from 11 million in February).
  • While Apple’s mobile payment service Apple Pay doesn’t meaningfully contribute to revenues yet, it has been recording strong user growth. The service is currently adding about 1 million new users per week, and transaction volumes are 5x what they were a year ago. [3] Over 2.5 million locations now accept the service in the U.S., up from just 220k locations when the service was launched in 2014.
  • Apple consolidates its Watch revenues under the “Other Products” segment which also includes iPod and accessory sales. While the segment recorded a 30% year-over-year increase in sales (+$500 million over Q2’15 when the Watch was yet to be launched), it’s likely that Watch sales exceeded this number, given that iPod sales have been shrinking fast.

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Notes:
  1. Apple Q2 2016 Press Release []
  2. Gartner Says Worldwide PC Shipments Declined 9.6 Percent in First Quarter of 2016, Gartner, April 2016 []
  3. Apple (AAPL) Timothy Donald Cook on Q2 2016 Results – Earnings Call Transcript, Seeking Alpha, April 2016 []