When Apple reports earnings after the close today, all eyes will be on its revenue, specifically how many fewer iPhones it sold in the quarter (consensus expects a drop of 22%), and more importantly profits for one reason: over the past several years Apple has been the single biggest contributor to S&P profitabillity. In 2015, Apple’s profit rose 21% and it made more money than any other company in the S&P500 – at $53.7 billion in net income it accounted for 7% of the S&P’s bottom line.
However, that ended promptly in the first quarter when APPL posted a substantial drop in both EPS and iPhone sales. It is about to get worse: according to Drexel Hamilton’s Brian White, “the company is heading for its biggest iPhone decline ever.”
As such, AAPL is truly in a class of its own, details of which are revealed courtesy of FactSet’s John Butters who writes that for the calendar second quarter (fiscal third quarter for Apple), the current mean EPS estimate is $1.40, compared to year-ago actual EPS of $1.85, a 24.5% decline on the back of a 22% drop in iPhone sales. If Apple reports a year-over-year decline in EPS for Q2 2016, it will mark the second straight quarter that the company has reported a year-over-year decline in EPS. The last time Apple reported two consecutive quarters of annual earnings declines was Q2 2013 through Q3 2013 (fiscal Q3 2013 through Q4 2013 for Apple).
As a result of this projected decline in EPS, Apple is expected to be the largest contributor to the expected earnings decline for the S&P 500 Information Technology sector for Q2 2016. The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for the Information Technology sector is -3.9%. Excluding Apple, the blended earnings growth rate for the sector would be 2.2%.
More surprising, is that while market participants have a habit of excluding energy companies when looking at S&P performance, what they should be excluding instead is Apple (and Google). As the chart below shows, while the EPS of the S&P500 are expected to decline 3% in Q2, if one excludes just AAPL and GOOG, revenues would increase by 2%, while EPS would rebound 6% Y/Y. In fact, the benefit of excluding AAPL and GOOG for Q2 S&P500 results is greater than excluding all Energy companies.
As of today, if Apple reports actual EPS equal to or below the mean EPS estimate for the quarter, it will mark the first time that Apple has been the largest detractor to earnings growth for the Information Technology sector for two consecutive quarters since Q2 2013 through Q3 2013.
Should AAPL disppoint, the responsible culprit will be just one: the iPhone. Over the past three years on average, the iPhone product segment has accounted for about 60% of the total revenues generated by Apple. From Q1 2014 through Q4 2015, the iPhone product segment reported average year-over-year revenue growth of 31%. However, last quarter (Q1 2016), the segment reported a year-over-year decline in revenues of -18%. For Q2 2016, the iPhone product segment is projected to report a year-over-year decline in revenues of -22%.
Still, even in a worst case scenario when AAPL misses already substantially discounted earnings, the story is not over according to Drexel Hamilton. As the abovementioned White writes, “similar to the negative sentiment that engulfed Apple in late 2012 through the summer of 2013, the “gloom and doom” around Apple resurfaced in late 2015 and has picked up steam in 2016. Akin to the dog days of 2013, we believe this summer will prove to be a bottoming process for Apple’s stock with our estimates pointing to a trough in the sales cycle, profit cycle and iPhone unit cycle in the June quarter.”
Then again, perhaps the magic has run out this time. Recall how Apple staged its dramatic recovery last time:
Apple’s launch of the iPhone 6/6 Plus with bigger screen sizes in September 2014 drove a massive upgrade that resulted in 37% iPhone unit growth in FY:15 and the after effect has us modeling an 11% decline in FY:16. This equates to average iPhone unit growth of nearly 13% over this two year period. Given more favorable comparisons and the expected launch of iPhone 7 this September, we believe iPhone units will resume growth in 2Q:FY17 and deliver growth for the full year FY:17. Although we expect a 25-35% YoY total 3Q:FY16 revenue decline in Greater China, India is ramping and we believe Apple has an opportunity to generate $10-15 billion in annual sales by FY:21. For 3Q:FY16, we are modeling iPhone units of 38.55 million and this 19% YoY decline represents the biggest decline ever, but also the trough in this iPhone cycle based on our current estimates.
It remains to be seen if AAPL can pull off two historic comebacks in two years, but for now we will watch what Apple reports after the close, where expectations are as follows:
- 3Q EPS est. $1.39 (range $1.32-$1.47)
- 3Q rev. est. $42.1b (range $41.2b-$43.7b); AAPL forecast $41b-$43b (April 26)
- 3Q gross margin est. 37.9% (range 37.5%-39.5%) AAPL forecast 37.5%-38%
- 4Q EPS est. $1.60 (range $1.39-$1.77); avg. est. down ~2.2% over past 4 weeks
- 4Q rev. est. $45.6b (range $42.4b-$49.4b)
- 4Q gross margin est. 38.4% (range 36.5%-40.0%)
UNIT BREAKDOWN
- 3Q iPhone unit est. 39.9m (11 ests., complied by Bloomberg News)
- iPhone ASP est. ~$606 (7 ests.)
- 3Q iPad unit est. 9.1m (9 ests.)
- iPad ASP est. ~$443 (5 ests.)
- 3Q Mac unit est. 4.4m (9 ests.)
- 3Q Watch est. 2.0m (8 ests.)
- Watch ASP ~$448 (5 ests.)
ANALYST COMMENTARY
- RBC (outperform): Expect 3Q rev., units in-line with ests.; potential for “more muted gross margin expansion” in 4Q and beyond due to iPhone SE, at least until iPhone 7 cycle kicks in
- Investors will focus on iPhone units/mix, operating expense dynamics and whether AAPL will curtail opex given slower demand
- Nomura (buy): 3Q and 4Q iPhone numbers look “uninspired” as SE demand has exceeded AAPL’s expectations, in part at the expense of 6s units
- Early indications suggest iPhone demand may steady in 1Q due to iPhone 7 and carrier promotions
- UBS (buy): Other than solid services growth and maybe some improvement in China, there “probably won’t be too many positives” in qtr, with SE success likely to pressure ASPs
- Oppenheimer (perform): Doesn’t expect 3Q results and 4Q forecasts to change view on AAPL; investors are looking beyond qtr to iPhone 7 introduction in Fall
- Expect iPhone 7 product cycle to be weak due to lack of major improvements, with more major update expected in 2017
HISTORICAL
- AAPL has beaten EPS est. 7 of last 8 qtrs, beaten rev. est. 5 of last 8 qtrs; shrs fell day after 4 of previous 8 qtrs
- AAPL 43 buys, 7 holds, 2 sells, avg. PT ~$123: Bloomberg data
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