Apple's first quarter will miss revenue targets amid what appears to be a possible global slowdown and CEO Tim Cook's missive on iPhone demand provides enough detail to ensure optimists and pessimists have plenty of ammunition.
The company cut its revenue targets to $84 billion and about $7 billion below Wall Street estimates. Cook blamed China demand, supply constraints of new products and weak iPhone upgrades in many markets. The fact that Apple cut its outlook just weeks after providing guidance in October highlights how quickly the tech market is shifting.
Here are some key takeaways from Apple's first quarter.
Apple is a luxury brand in China and that's a problem. Yes, Apple hits multiple price points with its products, but it largely depends on China for its growth. Cook said in its letter:
We did not foresee the magnitude of the economic deceleration, particularly in Greater China. In fact, most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad.
The trade war is taking its toll on China and uncertainty has it the financial markets and consumer confidence. When a Chinese consumer wants to cut a few budget corners, the home teams--Huawei, Oppo, Xiaomi and Lenovo--look like better fits.
Consider these market share stats from Counterpoint Research. The trade war just lit the fuse on Apple's China sales.
You can argue that Apple is just the tip of the luxury good spear in China. We'll know more as brands like Louis Vuitton, Chanel and Burberry report their quarters. These companies are heavily dependent on Chinese consumers.
The jury is still out on the iPhone strategy. Cook blamed iPhone revenue on China to a large degree, but the upgrade enthusiasm hasn't been strong. Cook said:
In some developed markets, iPhone upgrades also were not as strong as we thought they would be. While macroeconomic challenges in some markets were a key contributor to this trend, we believe there are other factors broadly impacting our iPhone performance, including consumers adapting to a world with fewer carrier subsidies, US dollar strength-related price increases, and some customers taking advantage of significantly reduced pricing for iPhone battery replacements.
Cook has a point on those upgrade challenges, but here are a few others.
- The differentiation between iPhone Xr and its more expensive siblings almost causes a pause in buying behavior.
- There aren't enough reasons to upgrade when you're buying a device without subsidies, which have been eradicated from carriers.
- Even Apple hits a pricing wall at some point.
- And there has been enough chatter about 5G's promise to force tech buyers to at least consider holding out.
In a research note, BTIG analyst Walter Piecyk made the following moves based on Apple's iPhone miss:
- Cut Apple's price target to $197 from $235.
- Cut iPhone revenue estimate by $25 billion for fiscal 2019 implying flat revenue growth year over year.
Apple is clearly a services company. Cook's letter noted that services revenue was $10.8 billion in the quarter and the business should double from 2016 to 2020. Future quarters will tell whether iPhone's lack of growth is due to platform jumpers or just folks extending device upgrade cycles. There's little evidence of Apple customers jumping ship.
What's unclear is whether Wall Street will get into the services story as much as they due mammoth iPhone upgrade cycles.
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Macquarie Capital analyst Benjamin Schachter noted that the iPhone miss is likely to hit services revenue at some point too. In a research note, he said:
We are quite concerned that Services growth is going to slow meaningfully beginning in the March quarter. In other words, just as investors hang on to Services as Apple's life preserver in the choppy seas, it is going to float away.
There are simply too many concerns (beyond the pre-announcement) to ignore. Tough Services comps are coming and we have significant concerns about the sustainability of growth for the key Services drivers. Specifically, we think the top three Services drivers (Licensing, App Store, and Apple Care) are all likely to slow in FY'19 and the faster-growing Services business (Music, iCloud, and Apple Pay) are not big enough to offset the slowdown (and Music margins are relatively low).
Apple is still in great shape. Yes, the Apple concerns will take center stage, but for perspective the company will deliver first quarter revenue of $84 billion. Analysts were expecting $91.5 billion. That's a big miss, but gross margins of 38 percent are roughly in line and so are operating expenses. Apple remains efficient and earnings will be at all-time record levels.
The caveat to Apple's position is that it may not last. Oppenheimer analyst Andrew Uerkwitz said:
We believe the press release and guidance miss raises more questions than answers. 1) What is wrong in China? 2) Where does the iPhone go from here? 3) Is it clear yet, that Apple has a gross margin problem? The calming affect and what drives earnings growth in our model is capital returns. We remain solidly on the sideline as we continue to believe investors are not pricing in longer-term risks.
The company will take more control of the customer relationship. Look for Apple to use its retail footprint for everything from financing to trade-ins. Cook noted that Apple will accelerate plans to make it easier to trade in phones, finance and transfer data. That move to control more of the customer experience will make life more difficult for wireless carriers.
Apple's bet appears to be that trade-in deals can become akin to what the telecom subsidies used to be.