Apple share price: where next after earnings take a bite out of valuation

Apple’s revenue and earnings continue to head higher, and the company is trying to renew excitement about its future prospects through its digital services. But investors can’t shake fears that growth is about to slow amid a poor earnings season for big tech.

Apple
Source: Bloomberg

Confidence behind big tech is waning after the latest earnings season saw better-than-expected results overshadowed by warnings that the tremendous rate of growth they have delivered may have reached its peak and is set to slow.

The latest quarterly results from the likes of Amazon and Alphabet, both of which showed signs of slower growth than the market had expected, has spooked investors and seen the likes of the New York Stock Exchange (NYSE) and Facebook, Apple, Netflix and Google owner Alphabet (FANG) plus index (tracking the ten most liquid and innovative tech stocks including Alibaba, Baidu, NVIDIA, Tesla and Twitter) fall over 15% since hitting an all-time high in the middle of this year.

Amazon beat earnings expectations but said overall revenue growth in the final quarter – the busiest of the year amid the holiday season – could be just half the rate it is currently delivering, while Google’s advertising revenue growth was 2% slower than anticipated. The heightened issues around data privacy and fake news hurt revenues at Facebook and saw user growth and engagement both decline. And Spotify’s uninspiring results came with a warning that the loss-making company will see gross profitability take a hit in the last three months of this year.

Some did fare better than others. Twitter shares rallied after third quarter (Q3) revenue beat expectations and nerves about falling user numbers were calmed by the company putting it down to its crackdown on removing fake accounts. Microsoft delivered a more resilient performance after all its core divisions including LinkedIn, Office 365 and its cloud computing service Azure experienced strong double-digit growth, briefly allowing it to overtake both Alphabet and Amazon to become the second-most valuable company in the world behind Apple.

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Apple share price falls after Q4 results

Despite the whiff of caution coming from some of the sector, expectations for Apple were still high before the world’s most valuable publicly listed company released its own results. But uncertain guidance for the holiday season, reports it has scaled back its ambitions for the latest iPhone, and the announcement it will be less transparent over how many phones it sells in the future has left many feeling nervous about Apple’s ability to stay atop the tech tree this Christmas.

Apple iPad and Mac launches raises expectations before holiday season

Shortly before releasing its Q4 results to the end of September 2018, Apple had upped excitement about the prospects for the upcoming holiday season with its latest product launch that included a long overdue revamp of its Macs and the biggest overhaul to the iPad ever undertaken: not only is it slimmer and lighter than ever but equipped with new features such as a USB port, the wireless-charging Apple Pencil and a new keyboard to help it compete against ‘convertibles’ like the Microsoft Surface.

Following the release of its new iPhones and Apple Watches only months before, there is good reason to believe Apple is entering the busiest quarter of the year with what looks like its strongest line up for years. Reports soon started to surface that Apple’s sales in the final three months of 2018 (the first of its new financial year) would top $100 billion for the first time ever.

Apple Q4 results beat expectations but met with whiff of caution

Apple’s revenue in the three months to the end of September (rounding off the financial year) rose 20% year-on-year (YoY) to $62.9 billion – the fastest growth on record for three years and ahead of the $61.57 billion expected by analysts.

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While that gives good reason to cheer the guidance for the first and most important quarter of its new financial year, it also suggests Apple could be the latest tech giant to see a slowdown in growth. Quarterly revenue is set to be between $89 billion and $93 billion and the company would have to hit the very top of that range (which for Apple would not be unheard of) just to meet market expectations. That guidance was also a disappointment to those buoyed by its new products that were bandying about the $100 billion figure before the results were released.

Apple guidance suggests holiday season could be a hit or miss

Apple’s guidance for the coming quarter has left many disappointed for numerous reasons. The company had set the bar high in Q1 of the recently ended financial year, when it posted 13% growth in revenue to $88.3 billion. That rate had accelerated markedly from the quarterly revenue growth in the immediate two years of just 3.3% and 1.7%.

With that in mind, Apple’s guidance for Q1 of its new financial year provides little insight as to where growth is headed. At $93 billion, the top end of its range, Apple would deliver 5.3% YoY growth, considerably slower than the year before but still a significant rate relative to recent years. On the other hand, at the bottom end of the range, at $89 billion Apple would be delivering just 0.8% YoY growth. That would be one of the slowest rates on record for the company and, amid the slowdown evident among others in the tech space, investors have rightly become wary that Apple may follow suit.

Apple pushes prices higher but growth slows in emerging markets

The disappointing guidance and slower growth has been pinpointed down to markets in emerging markets (EMs) including Turkey, India, Brazil and Russia. This has sparked concern that Apple’s pricing strategy - which has seen demand growing despite each new product or upgrades becoming ever more expensive – is about to be tested by less affluent economies.

Pricing is poignant. It has long been known that volumes were beginning to stagnate, but Apple has countered this with higher pricing: iPhone sales in the latest quarter came in flat from the previous year but revenue was up 29%. The most expensive version of its latest iPhone model, the XS, costs north of $1200 compared to the last three ‘Plus’ versions that all cost between $750-$850, and older models released before 2014 were mostly priced below $500. It’s not just iPhones either: the new MacBook Airs and both sizes of the recently released iPad Pros are pricier than their predecessors (as are the accessories such as the Apple Pencil and keyboard).

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Apple looks set to continue raising prices to capitalise on its loyal fanbase that has long been willing to pay a premium over rival products. The focus on the price, however, is intensifying after Apple revealed it will no longer report how many units it sells and only report revenue figures for each product category. The number of iPhones being sold has been one of the closest tracked figures in the sector and often used as a gauge of how the wider market – rivals and suppliers – are performing.

Why is Apple no longer reporting iPhone unit sales?

While Apple has many reasons to stop disclosing unit sales, stating a ‘unit of sale is less relevant today than it was in the past’ and ‘has not necessarily been representative of our underlying business’, many consider it a pre-emptive move ahead of falling volumes. It is worth noting that Apple is not becoming more secretive than the rest of the industry but is taking away figures that it voluntarily supplied at a time when rivals didn’t bother – Samsung doesn’t outline unit sales.

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It is evident that revenue growth is increasingly being driven by price and not volumes. Disclosing unit sales was how the market calculated the average selling price of iPhones and its other products but, with unit sales now hidden away, investors will have less data to play with and it will be harder to distinguish what’s driving revenue. Apple has already refuted claims that the move is in preparation for lower volumes, stating its intention is to grow unit sales for all its products. The annual change in unit sales of iPads was down 6% in the latest quarter and revenue fell 15%, while Mac sales dipped 2% but saw revenue rise 3%.

Reports Apple has scaled down ambitions for latest iPhone model

The Nikkei Asian Review reported that Apple has scaled back its ambitions for the iPhone XR, a more affordable model that was recently released, asking contractors to dedicate fewer production lines than originally agreed and warning a backup supplier that they will no longer be needed. This has obviously fed fears over future sizes and supports the argument that Apple has looked to mask lower volumes.

The report states two of its main phone assemblers, Foxconn and Pegatron, have been asked to halt plans to add more production lines while Wistron, signed up in case extra capacity was needed this holiday season, has been told it will no longer be required. The report suggests Foxconn alone will produce 100,000 fewer iPhones each and every day as a result: up to one-quarter less than first anticipated.

Apple switches focus from iPhone sales to user base and services division

Apple is right to state unit sales are less relevant the more it focuses on maximising value and margins, but removing these figures is also to its benefit because it can mask the average price of its phones. As it charges more for its products and improves margins, the more consumers will begin to question the value for money and concentrate on Apple’s relentless approach to pricing.

Aware of this, Apple’s transparency around its services division consisting of apps like iTunes, Apple Music, App Store and iCloud is set to open up as it becomes more secretive about how many products it is selling. Services revenue hit $10 billion for the first time in the latest quarter, up 27% from $7.9 billion the year before, accounting for 16% of total revenue.

Apple chief executive officer (CEO), Tim Cook, has often said the company’s future lies in services. This area of digital products and services offers superior margins to selling hardware, and introducing new digital offerings is a far easier way of diversifying than constantly creating the next breakthrough gadget. Some analysts predict that services boast a gross margin twice the size of hardware. While overall margins have remained steady and higher profits are driven by prices rather than volumes, there is still room for improvement on this front as Apple switches from hardware to software and services.

Unit sales figures are therefore being replaced by the gross margin figures released for the services division for the first time. This will first be reported in its next set of quarterly results, when Apple is likely to begin telling a new story of future growth and opportunity around services that builds on its recent revamp of its entire product line.

This new financial year is set to be Apple’s attempt to reignite excitement around the company’s prospects at a time when the overall attitude to big tech’s future growth potential has soured. Cook said the firm’s installed user base is ‘growing at double digits’ and described it as probably a ‘much more significant metric for us from an ecosystem point of view’. However, investors are still unsure as to how much detail will be dished out on the division in future reports.

Apple shifts to services in search of next phase of growth

Amid the broader slowdown emerging among other big tech companies, the mood of the market weighed to the downside potential following Apple’s latest results and guidance. Fears over lower volumes may be justified but Apple is proving it has reason to switch its focus to its faster growing and more profitable services business and looks set to open transparency in more valuable areas of the company while closing useful but not essential data that its competitors don’t provide anyway, even if that does allow it to mask its pricing strategy and volume performance.

At the bottom line, Apple is still delivering double-digit growth and stellar returns. Net profit was up almost one-third in the last quarter of 2018 to $14.1 billion and, having returned a staggering $73 billion in share buybacks over the last 12 months, its diluted earnings per share (EPS) jumped from $2.07 to $2.91. For the full-year, net profit rose to $59.5 billion from $48.4 billion with diluted EPS of $11.91 versus $9.21, with the dividend raised to $2.72 from $2.40.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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