_____ Than Feared: iPhone 6s/Plus Are Mostly on Their Own for $AAPL’s Transitional FQ2 2016 (+FQ3 Quick Look)

(REMINDER: Please refer to the About + Disclaimer section. You won’t ever find actionable investing/trading advice here, just a humble home gamer in his corner of the Web trying to understand Apple and tech a bit better. As you know, no one has any clue what AAPL stock will do from day to day, quarter to quarter, year to year, even if earnings “seem good enough”.)

Also – TL;DR warning, more than usual. Don’t try reading this in one sitting. I know, the late posting doesn’t make things any easier.

A Relatively Glum Apple Quarter, Which, Like Many Before It, is Already in Wall Street’s Rear-View Mirror

As it so happens, the AAPL bears and skeptics were most correct about Apple’s FQ1 and its FQ2 guidance (yup, I’m more than fine admitting when I’m wrong) – though the stock itself had already bottomed out by that time of the late January earnings release.

Apple’s resistant, but not immune, to intense ForEx pressures and global macroeconomic uncertainty. Apple bulls (myself included) have had to recalibrate quite a bit, given the twin outliers of

(1) an incredible demand for iPhone 6/Plus (Apple’s very first BigPhone/HugePhone lineup), which may bear a passing resemblance to my “sales nova” hypothesis, and

(2) broad-based economic “nervousness” (since I don’t see any “world is in recession!” headlines in the news) putting a damper on global spending.

The question now is, has Wall Street crossed the line of overcorrection, or is the current consensus of around -3% revenue growth for the entire fiscal year actually giving Apple the benefit of the doubt?

Of course, there’s a gulf of difference between Apple disappointing Wall Street and Apple actually beginning to show signs of failure in an objective sense, whatever any hyperventilating members of the analyst/media/blogger class might tell you. Still, even the most ardent Apple bulls should (in my opinion) agree that a negative growth year, or even fiscal quarter (as FQ2 2016 is certain to be), is one worth watching – and doing additional research about – to check against the ol’ investment/trading thesis.

And yet…this quarter is already being looked past, as the recent price action appears to be confirming. Which is why, as I often do, we’ll take a quick look ahead to FQ3 2016 (“the iPhone SE and smaller iPad Pro quarter”) as well.

Welcome to my humble blog’s 12th home game AAPL earnings preview, where I try to understand the world’s most consequential and profitable tech company (well, most profitable non-government-enterprise company period) just that little bit better. My goal, as it’s been since ($)55 (7-to-1 split-adjusted), is to “compare numbers to narratives in what small measure I can”, for those Apple News readers (hey there!) who haven’t stopped by my WordPress blog before.


Apple’s Lowered FQ2 Guidance Bar, Plus the Formalistic-But-Somewhat-Meaningless “Stating of the Analyst Consensus for To-Be-Reported FQ2 2016” [as of April 21, 2016]

Here’s the FQ2 guidance from Apple:

  • revenue between $50 billion and $53 billion
  • gross margin between 39 percent and 39.5 percent
  • operating expenses between $6 billion and $6.1 billion
  • other income/(expense) of $325 million
  • tax rate of 25.5 percent

“Hey now, wasn’t FQ2 2015 revenue about $58 billion?

Yyyyyyyep. Which makes Wall Street’s net-non-reaction to Apple’s dour guidance somewhat amusing, even amidst a flurry of analysts’ downward revisions. You’ve heard about the “rough [fiscal quarter] compare” concerns throughout 2015, and so management finally brought that up early this year.

…though with a P/E multiple of around 10, it wasn’t exactly surprising that AAPL didn’t take much of a proverbial haircut despite the “dour” guidance. After all, there is a theoretical line of super-deluxe-supreme valuation insanity, which would prompt Luca Maestri, Tim Cook and company (in their very wildest dreams) to buy up a giant chunk of Apple stock (if the buybacks to date weren’t big enough), or…perhaps more.

As it so happens, the “10 multiple” – which is less than half the P/E ratio of the S&P 500 – is an approximate price support floor, at least until it isn’t, as they say. Good to know, heh.

Anyway, run the numbers and Apple’s guiding to a net income range of around $10.22 – $11.37B. That’s obviously down from the $13.6B in the year-ago quarter, and an anticipated year-over-year (YOY) decline in iPhone unit sales would probably be the #1 culprit.

Before everyone panics, 2015 was an insane growth year for Apple. Yes, management didn’t do much of anything to dampen expectations from 2016 (it’s not their style, which tends to be ridiculously close to the vest, and their general default state is to only give guidance about one quarter into the future). While management may not “communicate to Wall Street” as well as some bulls might like (not that saying “hey guys, advance warning about FY16” would help the stock any 😛 ), the fact remains that rock-bottom guidance of $50B revs and up + $10.22B net income and up is still growth from FQ2 2014’s then-impressive numbers of $45.6B rev/$10.2B net income. To be clear, this is only longer-arc-of-time-perspective, not an attempt to sugar-coat a virtually certain YOY decline in FQ2 revenues and profit.

Here’s what the 36-analyst consensus polled by Yahoo! Finance (not an endorsement per se, it’s just where I’ve always surfed to get the information) thinks about the FQ2 numbers: $51.97B (down about 10% YOY), and EPS of $2.00 (vs. $2.33 in the year-ago quarter)

* * * * * * * * * * *

Before moving on to my exceedingly humble home game take on FQ2 2016 results, a quick note on how FQ2 2016 fits in with analysts’ full-year consensus.

39 analysts polled/tabulated by Yahoo! Finance see Apple ringing in about $226.7B in revenues, which is down just about $7 billion from FY 2015’s astounding $233.72B revenue number.

FQ1 2016 revenue was around $1.3B higher YOY.

FQ2 2016 revenue is projected by the analyst consensus to be around $6B lower than the year-ago quarter.

Therefore, analysts are projecting Apple revenue to be about $2.3B lower in the second half of fiscal 2016, compared to 2H FY 2015.

How analysts get there exactly – and whether the consensus for this interval is too high, too low or about right – who knows. I will offer this, though, for what little it’s worth (note the About + Disclaimer section).

Analysts have been making noises about iPhone 7 being a tailwind, even though its sales in FQ4, if any, will surely pale in comparison with its first full quarter of availability in FQ1 2017. That is, if Apple continues with its typical flagship iPhone release cadence. So, perhaps analysts think the worst of Apple’s “down year” is finished by FQ3? That’s just my wild guess. I mean, they’re already down on FQ2 to the tune of $6B year-on-year. Unless one of FQ3 or FQ4 “really turns the corner” in their eyes, it’s a bit tricky to see them being this level of pessimistic for FQ3. As always, we’re only left with those notes and interviews made known to the public.

One last thing before the Quarterly Horseshoe Toss on Apple’s quarterly numbers. It’s beyond my pay grade, but still worth considering whether and to what extent analysts are “accounting for” iPad Pro 9.7, iPhone SE or other non-iPhone 7 products (such as a potential Watch 2) in their thinking (read: numbers so far) for the second half of FY 2016.


The AAPL Tree “I Bet Mav’s Overcorrecting This Time Around Because He was Too High for FQ1” Horseshoe Toss for Apple’s Reported FQ2 2016 Numbers

With a bit of “commentary” to follow the “estimates”. Note: For Entertainment Purposes Only. It’s OK if you chuckle, the world could always use more humor.

Screen Shot 2016-04-24 at 9.57.00 PM

What manner of wild guess is this?! And — that garish formatting —

Your opinion on my aesthetics aside, at this point…let’s call it a working theory. Of mine. It may be net too conservative. And I never said it was a theory that would actually turn out to work…well, never mind. I’ll explain my so-called “thought process” and we’ll see how it squares with Tuesday’s earnings release, shall we?

Biggest, “most looming” question first. iPhone. Where, to, begin.

 


iPhone

Part One: “Q&A”

Hm. What did management say (in remarks, and to analysts) on the FQ1 2016 call? Excerpts courtesy The Street’s free earnings transcripts service.

Tim Cook, in general:

Our results are particularly impressive, given the challenging global macroeconomic environment. We’re seeing extreme conditions, unlike anything we’ve experienced before just about everywhere we look.

Cook, concerning China:

We know the conditions in China have been a source of concern for many investors. Last summer, while many companies were experiencing weakness in their China-based results, we were seeing just the opposite, with incredible momentum for iPhone, Mac and the App Store, in particular. In the December quarter, despite the turbulent environment, we produced our best results ever in Greater China, with revenue growing 14% over last year…

Notwithstanding these record results, we began to see some signs of economic softness in Greater China earlier this month, most notably in Hong Kong. Beyond the short-term volatility, we remain very confident about the long-term potential of the China market…

Luca Maestri on tough compares:

As you know, we don’t provide guidance beyond the current quarter and it’s difficult for us to forecast economic and foreign exchange factors; however, at this point, we believe the March quarter faces the most difficult year-over-year compare relative to the rest of the year.

The ever-bullish (no, not really) Toni Sacconaghi (Sanford Bernstein) on iPhone units:

To start, just on iPhones, it looks like your guidance implies about a 15% to 20% unit decline in iPhones for fiscal Q2…

Cook’s response (omitted that part about macro factors because it’s duplicative):

Toni, we do think that iPhone units will decline in the quarter. We don’t think that they will decline to the levels that you’re talking about. We aren’t projecting beyond the quarter, as Luca mentioned earlier; but at this point in time, we see that Q2 is the toughest compare. We believe it’s the toughest compare because of the year ago quarter also had catch up in it from Q1. If you recall, we were heavily supply constrained throughout the whole of Q1, and so some of that demand moved into Q2.

(Boldface emphases are mine.) Hmm.

And finally, a question from Kulbinder Garcha:

My question’s for Tim on the iPhone business. You talk a lot about the macroeconomic weakness weighing on units, but is some of the issue just that last year replacement got accelerated and this year it’s kind of normalizing, and that’s kind of a one-time headwind in terms of the unit growth that you see in that business. Is any of that going on, or is that not material, in your view?

On the normalizing aspect of the question (I actually have an upcoming post on this general topic, should Apple News approve my conversion request from RSS), Cook’s replied:

In terms of your initial question about is there some of the compare issue that are people that ran out quickly to buy a 6 and 6 Plus and sort of accelerated? There is no doubt that we had an unbelievable year last year, and the Q2 was particularly really, really strong because of the pent-up demand that left from Q1 in addition to Q2. And so there’s no doubt about that.

However, I think you can tell from the numbers that Luca is talking about just on the currency side, and that’s before thinking through the affect that price increases can sometimes have on the business over a period of time, it’s clear that the economic piece is large.

Once you skim through it, the major themes are pretty straightforward:

• “It’s the [world] economy, stupid.” (Of course, it’s up to you how where you place that on the “totally legit explanation” to “convenient excuse” spectrum)

• Normalization plays some role. (A bit more on this in the next section.)

Tim Cook disagrees on degree, and is fairly unequivocal in commenting that Apple’s seen the worst of the “iPhone downturn”. An important point which is nonetheless not far from the typical-Apple-inscrutable version of “color” (in terms of getting anything “concrete”).

Part Two: A Bold/Random/”Oh-What-the-Heck” WAG

What do I think? Well, not like it matters, but as mentioned several thousand words ago 😜, there does seem to be a widespread sense of economic unease, and it’s hard to argue with the dampening impacts of international currency weakness.

And it’s also hard to argue with the notion that iPhone 6 brought a “sales nova”, considering the unbelievable 37% unit sales growth from FY 2014 to FY 2015 from an enormous unit base of 169.2M iPhones sold. (By the way, revenues were up an ionospheric 52%, or 53 freaking billion dollars year on year). A bit of should-have-anticipated-it “whiplash”, versus “backlash”?

And yet, when Toni “Eternal iPhone Sunshine” Sacconaghi (so I’m being a bit mean here) throws out a specific “15-20% (YOY) drop in iPhone units”, and that’s met with resistance from Cook…well, have a look at my iPhone scribbles above.

But first, ASP. It was absurdly high in the December quarter – $691, as impaired by $49 in foreign exchange impact according to Luca Maestri. In other words, the ASP was just shy of a 64GB iPhone 6s or 16GB iPhone 6s Plus, both retailing for roughly $749 unsubsidized.

schiller-gif

So…what about ForEx in FQ2/CQ1 2016? Apparently, the dollar’s weakened considerably (versus several major currencies), which I think means ForEx headwinds have lessened sequentially. On the other hand, the dollar has, on balance, strengthened against the yuan.

Then there’s the inevitable, expected (perfectly normal) mix-shift away from the latest, greatest and most expensive iPhones following the first full quarter of availability. The fact the iPhone did finish FQ1 within the 5-7 week target channel inventory range (low end) will reinforce this phenomenon to some degree.

Given all this, I think my ASP estimate of $21 lower sequentially seems at least reasonable.

Now, the question of units. Well, a 16.6% YOY unit decline, as I’ve “estimated”, is an express rejection of Tim Cook’s earnings commentary. To Sacconahi’s “iPhone’s going down 15-20% in units YOY, isn’t it” question, Cook replied, “we don’t think that they will decline to the levels that you’re talking about”

And generally speaking, betting against Tim Cook and “Tim Cook’s Apple” (oh, that insipid cover page font) is the stupidest of ideas.

And, for every million iPhone units sold, revenue jumps $650M or so.

Oh well, so be it. Conservatism in my “estimates” is an enduring goal, even if it gets thrown out the window on this blog now and then, and so I’m reaffirming it. Even as I fully acknowledge that Tim Cook’s “setting a floor” on iPhone units at “no lower than about 52M units” sold by that statement – maybe even a bit higher, even the apparent extent of his disagreement with Sacconaghi. I’ll recalibrate what little I can based on Tuesday’s results.

As for the question of trending from here? I don’t have much to offer, and I’m not just saying that because I have anything awesome in the works – it’s a hopefully-near-future post, and nothing more. It’s just that visibility is particularly poor for home gamers, when you have an utterly unprecedented demand spike in iPhone 6 which may require some time to “normalize”, combined with a bit of “we’ll wait for iPhone 7” dynamics plus tangible, worldwide consumer jitters. iPhone SE will help, I believe, but the “smaller iPhone” market is starting from a relatively “small” base of 30M units.

Greater China did continue to be a resilient growth market, with revenues up 14% YOY for the revenue geography in FQ1. Then again, Cook cited significant economic softness in Hong Kong, a smaller but still significant portion of Greater China revenues. So, who knows about FQ2.

Three of Apple’s revenue geographies were positive for FQ1, and the revenue guidance strongly implies “negativity” across the board. Hopefully, tomorrow’s data points will help sort things out a bit on the fortunes of this exceedingly important business line.

Next up, iPad.

 

iPad

Not much to say here. The downtrend has been relentless and it was worsened by the lack of any movement – no new product, no price drop – in the mid-range iPad Air/Air 2 product lines.

On the other hand, when iPad units are in the 10M-or-so band, new product can provide a boost. iPad Pro 12.9, for instance.

So, simply overflowing with optimism, I’ve decided to home-game-guess a 22% decline in iPad units year-on-year. Which would place the percentage growth at third-lowest in the last 10 quarters of unit growth, the last nine reported so far being (from FQ1 2014): 14%, -16%, -8%, -13%, -18%, -23%, -18%, -20%, -25%.

I’ve decided to be perhaps-to0-bearish on iPad because while iPad Pro 12.9 will help, iPad Air and Air 2 continued to hurt (rumors of new 9.7″ iPad surely didn’t help the March quarter’s numbers). iPad Air 2 only received a price drop at the very end of FQ2, and iPad Pro 9.7 (which I’ve bored a few people to tears about) launched on March 31, in FQ3.

I think iPad Pro 9.7 could really slow down the rate of iPad YOY unit “decay”, if nothing else, but we’ll likely have to wait another three months for more clues. The “upside” of iPad’s quite-possibly-worst-quarter-for-a-while? The better iPad Pro 12.9 does, the greater its impact on ASP…which is why I’ve guessed that ASP increases about $15 sequentially.

Mac

 

Last 9 quarters of unit growth:

19%, 5%, 13%, 21%, 14%, 10%, 9%, 3%, -4%

To be honest, I’m kind of at a loss here. But net global consumer retrenchment plus a continuing downtrend in the PC market in general could, at least for now, explain the sudden downturn in Mac unit sales…it’s not like tablets are competing nearly as well for PC dollars lately.

There weren’t any new Macs introduced in FQ2, as I recall.

So…yeah. That’s it. A 1% YOY increase projection may be too high, but at Mac’s 20M-ish unit/year scale, a “miss” will have very little effect on Apple’s overall result.

Watch

To some, Apple Watch is being treated like a flop, a disappointment.

Me, I’m treating Watch simply as a purely incremental tailwind for FQ2 – because it didn’t ship until April 24, 2015 (FQ3 2015).

Even so, I’m being cautious – at least I hope. Basis for this? My random guess for the first full year of Watch sales was 10M (generation, first year, that’s basically the same), which apparently was conservative.

With that in mind, I “projected” unit sales of 2.25M units, tracking below a 10M/yr. run rate (there is some expectation of annual-ish refresh based on iOS devices after all), plus a conservative $375 ASP. This is based partly on Watch’s “invisibility” in FQ1 2016 (see also: units), plus the March 21 iPhone 1-esque price drop of $50 for aluminum Watch models, possibly indicative of a move to increase demand which won’t take “full effect” until the June quarter.

Services

As long as Apple adds new customers (and as of FY 2015, you can’t seriously argue the opposite), that tends to positively impact Services revenue.

And as long as Apple adds loyal customers who take an increasing liking to Apple over time, that creates its own sub-demand curve for existing users, and especially new users. Read: New customers in FY 2015 aren’t about to stop spending in FY 2016 – I’d think spending will increase overall.

Because of this, I’m theorizing that Services revenue should be fairly steady for FQ2, and probably all of FY 2016. A YOY gain of 8% (last nine quarters of growth: 19%, 11%, 12%, 8%, 9%, 9%, 12%, 10%, 26%seems all kinds of sober to me, considering what looks to be an Apple Music-fueled boost in growth for FQ1. Probably too low on this one – what are ya gonna do. Well, not take anything I write as actionable, that’s for sure!

Other Products Minus Watch

Very soon, this category will be meaningless – compares will be to year-ago, Watch-inclusive quarters. In yet another effort to be conservative (to the point of going overboard), I decided to envision a quarter where Beats hardware sales continue to be a letdown, with iPod continuing to fade away. A YOY reduction of 17% ex-Watch, with some of it possibly due to aggressive (but I can’t prove it at all) channel inventory drawdown in order to provide Apple Watch additional cloud cover.

Gross Margin

Maestri continued to sandbag on gross margin, even if the beat in FQ1 was just 10 basis points (.1%). Still, ForEx pressures appear to have lessened, and while revenue leverage will be a factor, Maestri still guided to a top-end gross margin of 39.5%, an impressive show of profitability strength.

Gross margin may or may not be affected by iPhone SE and iPad Pro 9.7 in FQ3 but that’s a question for later – in the here and now, iPad Pro 12.9 and iPhone as a product line should help keep margins up to Apple’s (as of now) standard. So, I’m guessing 39.9% gross margin – which may be a touch high.

Buybacks

Apple’s still buying, of that I’m pretty certain. The extent doesn’t have a particularly large effect on EPS, though, so I’m sticking with a “95% of the year-ago diluted shares outstanding” heuristic, which also corresponds to a very conservative net share-weighted buyback of 54M shares, or around $5B-ish of such repurchases in sequential terms.


The “Not Quite So Bad” FQ3 Compare?

I’m fully aware of the massive word count, so I’ll be wrapping up quickly.

Analysts polled by Yahoo! Finance, as of this weekend, expect Apple to ring in sales of $47.32B, about 4.6% lower than the year-ago-actual $49.6B in FQ3 2015 (or, coincidentally, $2.3B lower, which you can also think of as “100% of analysts’ decline-in-revenue projection for the rest of FY 2016“).

There’s plenty of “puts and takes”, but some X-factors (of which Watch is presently excluded) that come to mind:

(1) the ForEx situation;

(2) the product cadence shift of iPhone SE and iPad Pro 9.7, where the FQ3 interval has lately been completely devoid of any significant iOS product launches;

(3) Greater China (obvious, yes I know);

(4) any new Mac developments by WWDC (since that’s in June, a smaller factor); and

(5) believe it or not, Apple Music, which will be fully incremental vs. FQ3 2015 (no one started paying for Apple Music until FQ1 2016), unless iTunes Match or iTunes Radio were doing fantastic business before. Heh.

Well, that concludes my “dozenth” AAPL home game earnings preview. Hopefully it helps with your understanding or forming your own thesis on Apple financials, if nothing else.

The wait’s almost over. Let’s see what cards Apple shows in around 36 hours.

 

 

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