Apple Inc. (AAPL, Financial) announced its fourth-quarter results on Tuesday and, in light of drastic but anticipated reductions in iPhone sales, the stock nonetheless rose 1%. In hindsight, CEO Tim Cook’s decision to get out in front of the coming bad news by nipping it in the bud with an unprecedented pre-announcement Jan. 3 was most prudent.
The company registered its first drop in holiday revenue and profit in over 10 years. Overall revenue fell 4.5% year over year to $84.3 billion. Its profit dropped slightly to $19.97 billion. The company earned $4.18 per share, a penny less than the Street’s estimate of $4.19 per share.
Apple projects revenue of $55 billion to $59 billion for its March quarter, below the analysts' average consensus of $59.98 billion. This comes as no surprise to analysts, as they expect the number of iPhones sold in March to decline at the steepest level in Apple’s history. Some viewed the numbers as good news given the substantially diminished expectations for iPhone sales.
A review of the company’s overall financials contrasted with revenue from non-iPhone businesses will be instructive. The numbers demonstrate the high price the company is now paying for putting all its revenue eggs in one basket.
For the past several years, iPhone sales have accounted for almost two-thirds of the company’s overall revenue. The latest results posted paint a grim picture for any rebound. Smartphone sales dropped to $51.98 billion from $61.1 billion a year earlier. The decline in iPhone sales in one of the company’s most lucrative markets was particularly pronounced. Apple’s total sales in China fell 27% to $13.17 billion. To add insult to injury, the Chinese economy is in the throes of a substantial contraction, which will only drive iPhone sales from China even lower.
The company’s plans to make up for dramatically slowing sales in the Chinese market by penetrating the high-potential Indian market have been a colossal flop. Apple posted revenues of $1.8 billion from India for 2018, which is less than half of what it had hoped to capture. The experience in India is a foreboding sign and should prompt the company to implement its services integrations with alacrity.
The challenge for Apple is that unless the iPhone, once the flagship of the fleet, is supplanted with other services, it will act as an anchor on the future earnings prospects for the company.
Clearly, Cook’s “Let’s squeeze blood out of the iPhone stone” while neglecting to plan in advance for its sales growth demise was injudicious and the company is now paying the price for its strategy of maximizing short-term profit. Apple was caught off guard with the downturn in China in November and December; that sentiment doesn’t reflect well on senior management who seemed to harbor the belief in the iPhone’s market invincibility and its price elasticity. In light of his serious lapse in judgment, the timing of Cook’s recent 20% pay hike clearly couldn’t have been more inauspicious.
The company posted enviable numbers for its other business units: Revenue of the iPad jumped 17% year over year to $6.7 billion, the iconic device’s best period of growth in nearly six years. Revenue for Apple watches rose 33% to a record $7.3 billion. Revenue from Apple’s services arm (the anticipated silver lining in the cloud) rose 19% year over year to about $10.9 billion. However, this represents a foreboding deceleration from six straight quarters of 20% growth. As impressive as these results appear, it is like putting a bandaid on a wound that needs a tourniquet.
Here is the depressing reality: were Apple’s subscription services business to grow by more than 50% over the next two years, consistent with many analysts’ projections, it still would account for less than 25% of its total business. In short, Apple has a long way to go in taking steps to replace lost iPhone revenue.
Even though the other characters in Apple’s hardware cast showed robust sales growth, it is highly unlikely that revenue growth among these premium priced devices can be sustained. Apple reported an 8% increase in sales for active devices to 1.4 billion. This represents a deceleration from the more than 15% compounded annual growth rate between 2015 and 2018. Sales of Macs, iPads, subscription services and other products rose by 19%.
The problem for Apple is that the consumer market for its high-end, premium priced devices, particularly the laptops, is limited. Given the exorbitant prices, the company cannot hope for replacement cycles for these devices comparable to the same replacement rate for iPhones. The iPhone’s demise, in part, is related to consumer resistance to ever-increasing prices and the perceived need to replace existing devices. The same phenomenon is going to apply for its MacBook Pro laptops and high-end iPads.
Although the company believes it can reach its goal of $50 billion in total services revenue by 2020, this projection seems unduly optimistic and may be too little, too late to elevate the stock price in the near to intermediate term. It is apparent that too little attention was paid to expansion into other areas, including producing original content and plans for being a player in the digital streaming market. The company has done little to nothing to get these potentially lucrative businesses off the ground.
In this regard, given its enormous resources, Apple’s laggard pace in planning for entry into the original content market is mystifying. The company’s inexplicable delay in establishing a presence in the growing digital streaming market will prove to be costly.
Those investors who believe Apple can supplant eroding iPhone sales with its services offerings are going to be sorely disappointed. Some security analysts believe investors will assign a higher multiple to the stock for projected growth in its subscription services business. However, this seems fanciful; what is the factual basis for such an assertion? Although Apple is currently selling at $163 with a modest price-earnings ratio of only 13.4, compared to its September multiple of 20, Apple will need to show sustained and substantial growth in its subscription services business to justify some analysts’ current valuation of $200.
Disclosure: I have no position in any of the securities referenced in this article.
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