Apple Faced With the Reality of a Flat Future

Unless innovation is rekindled, company's fortunes will be flat

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Apr 14, 2017
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Apple (AAPL, Financial) reported record iPhone sales of 78.29 million units during the first quarter of 2017, the biggest quarter iPhone has had since its launch in 2007. But smartphone penetration in developed markets is already at a high, and reports from Gartner indicate that the global devices segment, which includes smartphones, has already seen its best years.

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With the bulk of its revenues coming from smartphone sales, Apple faces a period of slowdown in revenue growth. In 2016, worldwide smartphone sales to end users reached 1.5 billion units, growth of 5% compared to 2015. As you can see from the sales chart above, the rapid growth that Apple iPhone witnessed during 2007-2015 has been replaced by slow growth in 2016 and 2017.

"The global devices market is stagnating. Mobile phone shipments are only growing in emerging Asia/Pacific markets, and the PC market is just reaching the bottom of its decline," said Ranjit Atwal, research director at Gartner.

The launch of Apple’s iPhone 7 helped push sales during the first quarter of 2017 compared to last year, but let’s not forget that there was one extra week added during the first quarter, which helped bump overall sales numbers. iPhone 7 itself was not considered a new product but more of an incremental upgrade to an existing one.

How the market reacts to the product in the next few quarters will be crucial to iPhone’s short-term future. Apple has already lost its most valuable brand status to Google this year, a clear sign that Apple’s device kitchens are running short of a key ingredient called innovation.

One cannot deny that iPhones have become product refreshes more than anything, and the company is yet to launch a revolutionary new product that can take the market by the storm. With no “new” products coming out of Apple’s orchards, the company is dependent on iPhone sales, which will, in turn, be dependent on how frequently people replace their old phones with newer models.

Smartphone penetration is still low in emerging markets, and that is where most of the future growth for the segment is going to come from. But as a premium product with a high price tag, Apple’s potential market size in these nations is limited. Apple is trying to counter that by pushing the lower-cost iPhone SE, but even that costs nearly $400 – way out of reach for the bulk of smartphone buyers in markets like India.

Have iPhone sales already peaked?

Sales of iPhones may have already peaked, but it really depends on the market position that Apple wants to maintain as much as on Apple’s ability to launch another smartphone that can fire up users’ imaginations the way the first iPhone did.

If Apple starts adding more iPhones at lower price points, it can increase the number of units sold, like Samsung (XKRX:005930, Financial) with its broad range of price bands. But the odds of Apple doing that are right next to zero. Samsung, on the other hand, bagged the lead position in the March quarter for smartphone marketshare, mostly on the strength of its lower-cost models like the J Series.

But Apple, thanks to the premium positioning of the product, is able to charge a hefty premium. The positive result of that is profitability. Apple is the only company to be this profitable in the smartphone market and for so long, and that premium markup is what contributes to that.

“Third-quarter smartphone (2016) operating profit reached $9 billion globally of which Apple took 91% of the share, Strategy Analytics said in a note on Tuesday. This amounts to $8.19 billion for the U.S. technology giant.”– CNBC

Apple is not going to chase meaningless unit count numbers and sacrifice the profits and margins that will inevitably disappear if the company takes that road. If Apple’s sales have not already peaked then, at best, it can start moving sideways if it stays put with its product positioning. Unfortunately, that would mean slow revenue growth in the short to medium term.

This is the reason why Apple is trading at a lowly 17 times earnings, and it might continue to do so for some more time, at least until the Cupertino tech giant figures out how it wants to use the $246 billion cash horde that sits overseas – or until it launches a new product or a new service. Because what they have right now is not going to move the needle for them, and that includes the highly discussed iPhone 8 that’s coming out during the third quarter of this year.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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