This analyst report was written by analysts Timothy Arcuri and Munjal Shah
Apple Inc.
Services Good, But China Headwinds Intensifying; Cutting Target On Negative Pre
CQ4 neg-pre on weak China demand; services an important silver lining
AAPL announced preliminary FQ1:19 (Mar) results w/revenue ~$84B versus prior $89- 93B guidance due almost wholly to weaker than expected emerging market demand, particularly in China. Despite the ~8% revenue miss, GM of 38% was still at low-end of guide; other line item results imply EPS of ~$4.20 vs Street ~$4.70. The release implies China revenue declined ~25-30% Y/Y, declines last seen during the iPhone 6S cycle due at that time to very tough iPhone 6 comps. Services notably strong w/revenue $10.8B, or ~$500MM ABOVE our model. While we are cutting AAPL estimates and price target, to us this speaks more about why it is too early to get more +ve on semis.
Results imply ~64MM iPhone units, or ~9-10MM shortfall
AAPL will no longer discuss iPhone units, but given our view that shortfall was primarily iPhone XR-related (see here and here), results imply ~64MM units (vs ~73.5MM guide) and iPhone revenue down ~15% Y/Y – the worst CQ4 for iPhone by far. To that end, using historical Gartner data, we calculate iPhone units in China were flat to down Q/Q for the first time in a Dec Q, speaking both to the XR demand challenges as well as macroeconomic/trade headwinds. Given the XR-focused weakness, QRVO seems the most direct supply chain read and ~10MM is consistent w/its negative pre, though our procurement estimates still suggested that AAPL’s guide had factored much of this in.
PIVOTAL QUESTIONS
Q: How would iPhones perform in F19?
We forecast iPhone revenue to decline 12% in F19 driven by roughly 15% decline in units partially offset by 5% growth in ASPs. Macro uncertainties are impacting demand in emerging markets and developed markets are seeing elongating replacement cycle due to lower carrier subsidies and battery replacements. High retention rates would ultimately lead to upgrades.
Q: Could services drive 3-5% growth for Apple?
Services continue to see strong growth and drive overall revenue for Apple. We continue to expect solid 20% growth for the services business. However, our expectation for it to drive overall revenue growth is dependent upon stable hardware sales. Apple’s ability to increase services penetration, shift to favorable mix, and potentially new service offerings including bundles could drive further growth.
Q: Could Apple continue to innovate and what is its incremental TAM opportunity?
Apple has ample opportunities to innovate and increase its TAM by at least an incremental $1tn. Some markets Apple is targeting include AR/VR, video streaming, healthcare, autonomous vehicle ecosystem, among others. Some could be introduced in the medium term while others may take time.
UBS VIEW
iPhone demand is weak due to several factors –iPhone XR, China macro/trade issues, FX, emerging markets and longer replacement cycle. However, we continue to view the ecosystem being sticky. Services growth of 20%+ could continue with a huge untapped install base of 600mn+ active iPhone users. Apple could garner a higher multiple once investors start looking beyond the iPhone weakness and services margin disclosure shed light on recurring profits.
EVIDENCE
Apple lowered its fiscal 1Q guidance due to softness in iPhones, particularly in Greater China and emerging markets. Other products segments in aggregate saw revenue growth of 19% YoY. UBS Evidence Lab Survey in November suggested decline in buying intent with the UK and China intent below that seen during the iPhone 6s cycle. Replacement cycles are still elongating.
WHAT’S PRICED IN?
At 11.6x P/E, the stock is trading below the five-year average multiple and at a discount to S&P. In 2016, during the iPhone 6s cycle, the stock traded as low as 9.9x, but services was a much smaller business. Investor expectations for this iPhone cycle are muted. We now forecast iPhone units to decline 15% in F19 and revenue to decline 12%.
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