Apple is positioned to report another quarterly earnings beat when reporting 3Q results on July 21st. Apple continues to benefit from attractive year-over-year sales comparisons in China. Overall revenue growth is tracking close to 35 percent, with earnings growth exceeding 50 percent. With the iPhone now representing close to 70 percent of Apple's operating income, the product category has become the single-most important factor driving earnings, and that trend will continue in the near-term. With lingering Apple Watch demand questions, many will use earnings as the first opportunity to back into Watch unit sales. Apple guidance should be informative, reflecting not only a new iPhone launch, but also an early read on July sales and any impact from ongoing economic turmoil in China.
Earnings Preview Reading
Over the past three months, the major stories impacting Apple financials have centered around three topics: the iPhone's growing power, Apple's cash, and China Mobile. The following stories serve as good background reading in the lead-up to Apple earnings.
- The iPhone is Taking Over Apple - Apple will be the iPhone company for the foreseeable future. The iPhone's gravitational pull is simply too strong for any new product or service to reach escape velocity and become the next big thing for Apple in the near-term.
- Apple's Cash Dilemma - Apple is unable to keep the pace of share buybacks and dividends in line with its foreign cash generation.
- China Mobile is a Game Changer for Apple - China Mobile has become Apple's most important business partner.
iPhone: No Change in Momentum
Strong iPhone sales trends in China, Europe, and emerging markets will continue to offset lackluster smartphone growth in the U.S. Last quarter, I estimated China Mobile accounted for nearly 40% of Apple's year-over-year iPhone growth, which was certainly boosted by the Chinese New Year in February. China Mobile's importance cannot be stressed enough as the largest mobile carrier in the world will soon account for 20% of all iPhone shipments. Given lower smartphone adoption rate in China compared to U.S. and Europe, I would expect China to continue representing a majority of iPhone growth for the next few quarters.
Exhibit 1: iPhone Unit Sales Expectation Meter (3Q15)
Mac and iPad: No Longer Earnings Factors, but Still Interesting
Due to the iPhone's elevated share of earnings, the Mac and iPad are no longer relevant from an earnings day perspective. There are still interesting trends at play within each category. The Mac is continuing to take share in a category that is pretty much being decimated with overall PC shipments forecasted to be down 5-10% year-over-year this past quarter. The iPad continues to struggle as the product finds a normalized run rate where the combination of first-time buyers and upgraders results in roughly flat growth. We are not there yet.
Exhibit 2: iPad and Mac Unit Sales Expectation Meters (3Q15)
Even though Apple is not expected to disclose Apple Watch sales, keen observers with an Apple earnings model will be able to back into a relatively good approximation of Apple Watch sales. I am expecting Apple to have sold 4.25 million Apple Watches from April to June. While there has been much debate as to how the Apple Watch has been selling, more time will be needed to gauge normalized demand; there was evidence of pent-up demand at launch as would be the case with any new Apple product category.
Management's guidance will be useful for a few reasons. Since we are quickly approaching the new iPhone launch, guidance will help determine what Apple has seen so far in the month of July in terms of iPhone demand. While there shouldn't be much spillover just yet from the volatile Chinese stock market, any caution built into China sales due to economic concerns may become apparent in guidance. In addition, next quarter will present a more informative view on Apple Watch sales as we move away from launch.
Exhibit 3: Revenue and Margin Guidance Expectation Meters (for 4Q15)
Wall Street Concerns
The biggest headwind facing Apple continues to be fears of slowing iPhone growth in 2016. As has been the case for the past few conference calls, analysts will look for any new commentary on Android switcher rates and iPhone penetration in China and other developing markets. If 2015 was the year of China Mobile and large screen iPhones, company observers are becoming skeptical that the new iPhones will be able to sustain the same type of growth rates next year.
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