Can Apple’s Earnings Put Fears To Rest?

by Trefis Team
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A number of technology companies will be announcing earnings soon, but with the kind of volatility we are seeing in the market right now, Apple’s (NASDAQ:AAPL) is likely to be the most followed earnings release next week. The iDevice maker seems to have fallen out of favor with investors of late, with the stock tumbling more than 25% since the iPhone 5 was launched last year. A big reason for the recent downtrend has been multiple press reports about Apple cutting component orders for the iPhone 5, which have fueled concerns over a possible slowdown in demand for the latest iPhone. Still, despite the recent tumble, Apple’s stock has returned more than 20% over the past year, and existing investors will be interested to know if there is any substance to the rumors that have been floating. (see Sticking With Apple’s $700 Price Estimate In An Uncertain Market)

We will therefore be closely watching the iPhone numbers during the earnings call. While the quarter will, in all likelihood, be Apple’s best on account of the huge pent-up demand that had built up in anticipation of the iPhone 5 launch, the extent of y-o-y growth might see a slowdown despite the fast rollout. Verizon’s and AT&T’s smartphone sales guidance for the holiday quarter are out, which lead us to believe that Apple would have sold about 47-50 million iPhones during the quarter, around 30% higher than the year ago quarter. This, if true, will be a steep decline from the same period last year when the y-o-y growth was an astronomical 130%. While iPhone sales did benefit from an extra week’s sales last year, the potential slowdown in growth rate will be indicative of a saturating smartphone demand in developed markets such as the U.S. (U.S. smartphone sales grew y-o-y by just 9% in Q2). There is also the risk that iPhone 5’s mix among the phones sold is lower, implying lower ASPs and slackening demand for the latest iPhone.

See our complete analysis for Apple stock here

A cheaper iPhone may make sense

Apple will therefore be looking to tap the fast-growing emerging markets such as China to grow at higher rates. China, despite being only in the early stages of smartphone adoption, has already pulled ahead of the U.S. as the world’s largest smartphone market by volume. This is an incredible statistic given that 3G penetration in China stands at only about 20% currently. Considering the huge 2G subscriber base that the Chinese carriers are looking to upgrade to 3G, the potential for Apple to ride the boom is huge. This was borne out by the opening weekend sales for the iPhone 5 in China last month, which crossed the 2 million mark and made it Apple’s best ever launch in the country. We expect the launch to have helped shore up Apple’s market share in the region, which dropped to the sixth place in Q3 as people deferred purchasing an iPhone in anticipation of the new release.

However, Apple currently sells the iPhone through the smaller two of the three carriers in the country, China Unicom and China Telecom. A deal with the largest wireless carrier in the world, China Mobile, remains elusive until Apple can work out a subsidy deal with the carrier. How soon that will happen is open to speculation considering the Chinese government’s possible opposition to the huge iPhone subsidies. (see Apple’s China Potential Could Be Limited By A Subsidy Compromise With China Mobile) But knowing that the carrier’s 3G growth has been hurting due to unavailability of the iPhone, such a deal should not be too far along. This deal is very important for Apple as it can instantly double the iPhone’s current addressable market in China and act as the next big boost to its stock. (see Apple Could Have A $750 Fair Value If China Mobile Deal Works Out)

The important thing to note here is that despite not having a China Mobile deal, Apple hasn’t performed too badly in China so far. Revenues from greater China, which includes mainland China, Hong Kong and Taiwan, in the September quarter grew 26% year-over-year and accounted for 15% of Apple’s revenues for the fiscal year. This brought Apple’s FY2012 revenues from the region to about $24 billion, about 80% growth over FY 2011. In order to benefit more from the China potential, it may behoove Apple to consider a cheaper iPhone for the emerging markets that does not compromise much on the build quality and margins, in a move similar to the iPad mini. This will also help decrease the per phone subsidy costs and help it bring aboard China Mobile. We will therefore be watching out for comments on this front as well.

Watching iPad mini sales

Apart from the iPhone sales, it will be interesting to know how the company has performed on the iPad front. Given that Apple launched the iPad mini and the fourth-generation iPad as well during the holiday season, unit sales will likely be very strong this quarter. However, what investors need to look out for is the iPad mini mix since there is a risk of cannibalization of the higher-margin iPads. Currently, we are not expecting much of an impact either way since we estimate the iPad to account for less than 13% of Apple’s value. This may however change if the tablet market continues to grow exponentially. However, Microsoft’s entry into tablets with Windows 8 is a very potent threat to Apple’s continued dominance in the category.

Microsoft has a widely installed PC base in place that it can leverage to pose a big threat in the young market. Moreover, it can also leverage its partnership with Nokia and other handset makers to push for an integrated experience across all devices, mobile or PCs, in order to create a viable third ecosystem. The fact that Microsoft’s two-pronged attack with the Windows Phone 8 and Windows 8 could endanger Apple’s iOS ecosystem advantage, causing iPhone sales to be impacted as a result should give Apple more reason to worry than the low-end tablet threat.

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