Post Digest: Why Analysts Are Bearish on iPhone in FQ1 2016, NOT Just FQ2 2016, and Why Unit Growth Concerns May (Again) Be Overblown

The iPhone section of my FQ1 2016 Apple earnings preview may be of greatest interest to those interested in AAPL earnings season. So I’m posting it separately, since it essentially stands alone, plus is a much shorter read.

iPhoneThe Worst Best Thing to Ever Happen to Apple (No Seriously, Check the Stock Quote)

Last 8 quarters of unit growth:

7%, 17%, 13%, 16%, 46%, 40%, 35%, 22%***

***Remember, FQ4 2015’s numbers were heavily skewed by the “Missing iPhones” phenomenon, where perhaps 6M iPhones (maybe more, maybe less) were counted towards FQ1 2016, for a total of perhaps $4B in “deferred revenue” (maybe more, maybe less) on account of Apple selling iPhone with only two days to go in FQ4 2015, versus the “usual” nine days in the prior three FQ4s. I mentioned this near the end of my FQ4 2015 AAPL home game earnings preview, if you want more detail on how I arrived at those assumptions (link is here – it’s towards the end of the linked post). If you added 5 million iPhones back to FQ4, the YOY unit growth rate would’ve been closer to 35%.

It’s true that gloomy/skeptical/bearish/whatever analysts/pundits/blogger/whoevers 😀 are already looking towards FQ2 2016. And you know what, I can’t blame them. FQ2 2015 saw (1) the first full quarter of iPhone 6/Plus availability (2) in China (3) on a modest-sized China celco with about 800 million subscribers (4) amidst a mega-gigantic connection shift from 3G to 4G smartphones (5) during a time interval spanning Chinese New Year. So, insofar as FQ2 2016 represents a “tough compare” to the extent that China had a truly outlier iPhone quarter, I understand. It is a tough compare.

But, um, last I checked, there’s still a lot of the following type of sentiment out there, which seems a little too dour:

And if Wall Street thinks iPhone units might grow 1-2% or so from FY 2015 to FY 2016, they’re really thinking all of fiscal 2015 was a “tough compare” (which they do). And, by necessary implication, the growth floor completely falls out from under the Greater China revenue geography:

Despite China Mobile having some…fairly decent 4G adds for the holiday quarter (spoiler alert: December 2015 4G adds set an all-time record):

“Well, you see, it’s all gonna come crashing down soon enough. Besides, iPhone 6S, 6S Plus, and cheaper iPhone 6 and 6 Plus are passé in China. Because…it’s just this feeling I have.

Did I mention iPhone is so very expensive in China?”

All right, enough “trolling”. We can address the Samsung/Xiaomi Theory of Smartphone Momentum later.

Here’s what you get when you force-fit iPhone with a fairly reasonable, ForEx-affected ASP guess to a $77B revenue mix. You may disagree strongly, and that’s fine. (YOY iPhone/iPad/Mac growth percentages in terms of units):

REVENUES revs units “ASP”
iPhone $50.872B 76.5M 665
iPad $8.669B 18.25M 475
Mac $6.952B 5.675M 1225
Services $5.28B
Other Products ~$5.23B (Watch rev horseshoe toss: $2.78B, 5.05M units) Watch ASP Wild Guess: 550
YOY iPhone 2.73%
YOY iPad -14.8%
Total revs $77.00B YOY Mac 2.83%
YOY Services 10.02%
YOY Other Products 94.4%

(-8.89% ex-Watch)

Might ASP be higher than $665? Sure, but Tim Cook also mentioned a 700 basis point revenue headwind on a constant currency basis when comparing to FQ1 2015. That’s powerfully negative. I’m not sure how much of that 700 points could be mitigated by Apple’s ongoing, industrial-strength currency hedging program (it does appear currency hedging is “considered” in the guidance), but it’s probably not most of it. There’s also the very distinct possibility that iPhone 6 and 6 Plus remain vibrant and popular as they become the n-1 and n-2 (i.e., one-year-old/two-year-old) iPhones. They’re far superior mid-premium tier offerings compared to the iPhone 5S. Higher “mid-range” iPhone mix could mean a second dampening effect on ASP.

Might ASP be considerably lower than $665? Well…who here thought iPhone ASP would be $670 for FQ4 2015, a quarter that had exactly two days of iPhone 6S/Plus sales? An ASP that was higher than FQ2 (~$659) and FQ3 2015 (~$660) amidst horrific ForEx headwinds? I rest my case. Also, lower ASP means a likelihood of higher iPhone units. Additionally, consider Apple’s September 2015 accounting change, which removes between $5-10 of revenue deferral for each iPhone (read: increases ASP).

Now that ASP’s been addressed, let’s look at the concept of around 2.7% holiday quarter iPhone unit growth.

I have to admit, management did a convincing job of moderating iPhone expectations. Or…did certain analysts overindex on a single sentence? Let’s begin with this understatement-of-the-century line from Tim Cook (hat tip TheStreet’s free!, no-signup! earnings transcript service):

“We believe that iPhone will grow in [FQ1 2016]…”

I should hope so, Tim. And as for China:

Also, if I zoom out and look at China, as I’ve said before, and just to make the point once again, is we see an enormous change in China over the next several years. The latest study I’ve seen from McKenzie indicates if you look back five years, China’s middle class had about 50 million people and it, if you look ahead five years, it will have 10 times that number in it. And I feel like we are reasonably well positioned in China, I’m sure we can do better, but I think we are doing fairly well there.

(Emphases mine.) Do CEOs of companies this large…troll? Is that a thing? Now, to be fair, Tim did drop what I interpret to be a fairly bullish hint (at least as to FY 2016 overall), when responding to the eternally dour Toni Sacconaghi of Sanford C. Bernstein (something having to do with China being a first-stage launch country for iPhone 6S/Plus vs. having to wait until mid-October 2014 for iPhone 6/Plus, advantaging FQ1 2016 at the expense of FQ2 2016):

And where I think we will do quite good in iPhone, I do believe we will grow this quarter as we put in our guidance, that when you start with the number in the low 30s in terms of the percentage of the install base that’s upgraded, that had a phone pre the iPhone 6 and 6 plus, that number is still likely to leave a lot of headroom beyond December.

(Emphasis mine.) That’s a “macro” upbeat signal if I ever saw one, and it’s a clear signal about the install base unit sales opportunity (later in the call, Tim Cook would actually say the percentage of install base yet to upgrade was 69%, to make his point that much clearer).

Since Greater China is Apple’s fastest growing revenue geography, to the point of surpassing Europe for the first and likely final time, here’s Tim Cook answering a China economy/iPhone question from Shannon Cross of Cross Research:

Yes, if you look at China, we grew from an iPhone point of view, Greater China we grew 87%, the market grew 4%. If you take iPhone out of the market number so the market ex- iPhone actually contracted slightly. So we have been able to grow without the market growing. iPhone 6 was the number one selling smartphone in mainland China last quarter and iPhone 6 plus was number three. So, we did fairly well.

The economic question, which I know there’s been a lots of attention on, frankly, if I were to shut off my web and shut off the TV and just look at how many customers are coming in our stores regardless of whether they are buying, how many people are coming online and in addition to looking at our sales trends, I would not know there was — there was any economic issue at all in China.

(Emphases mine.) Sustainable megatrend or nitrous oxide boost from Fast and Furious. Within a country vitally important to Apple’s continued growth. Which do you believe? Or…should you believe?

As it so happens, 76.5M iPhones sold in FQ1 2016 – a number I independently mental-blended – exactly matches the Wall Street analyst consensus collected by Philip Elmer-Dewitt of Fortune Magazine. Two possible explanations spring to mind:

(1) You’d…think the pros accounted for the “Missing iPhones”, right? And that assuming channel inventory remains steady, they’re actually projecting an apples-to-apples iPhone unit decline in the neighborhood of 5% if those 6 or so million iPhones weren’t included?

(2) Or…maybe they’re assuming a major channel inventory drawdown? 13 weeks, 74.5M iPhones sold in FQ1 2015, adjust for possibly non-linear relationship of channel inventory to units sold per week…say, 1.5 weeks worth of drawdown vs. the year-ago quarter?

Well…according to Luca Maestri back in FQ1 2015, there was a YOY unit decline in iPhone channel inventory from FQ1 2014 to FQ1 2015 (-200,000 units), supply/demand balance wasn’t achieved until January 2015, and Apple ended up below the 5-7 week channel inventory target range on a look-forward basis (do note, Maestri does switch between look-forward and look-back from time to time if I remember correctly).

Huh…well, the channel was already starved as it was, I guess. And being conservative on channel inventory doesn’t mean you drain channel inventory to the point of straining your ability to supply product to the over-200,000 iPhone points of sale.

It’s safe to hold pros to a higher standard, so if I may be so bold – choose one concern, not both.

Wrapping up, iPhone estimates for FQ1, to my eyes, don’t reflect a fear-shift or anxiety-shift to FQ2 2016. Quite the contrary – the degree may be a tad lower vs. the upcoming March quarter, but Peak iPhone “concerns” are very much present in the December quarter Wall Street consensus.

Being as objective as I possibly can – I can’t help but think these iPhone concerns are overblown for the to-be-reported quarter, and a bit beyond.


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