Chinese smartphones and the iPhone has narrowed and Chinese consumers see less value in Apple products. ... call, manage
November 1, 2016 Mariano R. Viola, PhD Consumer & E-commerce Analysis (917) 751-3733
[email protected] www.violaadvisory.com
Apple, Inc. (AAPL): Short @ $95.00 Short Thesis: We believe Apple has Lost its Innovative Drive (the “Cool” factor) as new iPhones remain iterative of previous models. Apple needs to release a Product Road Map that describes the Technology Space it would like to occupy in 5 Years. While the iPhone is still a major Profit contributor, momentum is slowing and with it, Pricing Power. Furthermore, Apple is Losing Market Share in China as the technology gap between Chinese smartphones and the iPhone has narrowed and Chinese consumers see less value in Apple products. Apple has a large installment base that it could leverage for the next iPhone 8 product cycle (aka the “Supercycle”). However, we believe the iPhone cycle has matured and without new innovative products in the pipeline, Apple runs the risk of eroding its premium Brand Image.
TABLE 1: Apple F4Q16 Results F4Q16 Results
F1Q17 Guidance
EPS
Cons.
Result
EPS
Cons.
Result
1.67
1.67
in-line
n/a
3.23
n/a
F4Q16 Results Total Rev.
F1Q17 Guidance
Cons.
Result
Total Rev.
Cons.
Result
46.85B 46.83B
beat
76.0-78.0B
76.8B
in-line
Apple reported F4Q16 results with revenue of $46.85B slightly beating consensus of $46.83B and EPS of $1.67 in-line with consensus. F1Q17 revenue guidance between $76.0B and $78.0B was in-line with consensus estimate of $76.88B. Shares dropped 2.25% to $115.59 after management gave a worse than expected gross margin forecast for the holiday quarter. The market raised concerns about Apple’s ability to capitalize on high demand for the larger screen iPhone 7.
F4Q16 Highlights
• • • • • •
Revenue of $46.9B and quarterly net income of $9B, or $1.67 per diluted share vs. revenue of $51.5B and net income of $11.1B, or $1.96 per diluted share, in the year-ago quarter Gross margin 38% vs. 39.9% in the year-ago quarter International sales accounted for 62% of the quarter’s revenue Generated $16.1B in operating cash flow, a new record for the September quarter Returned $9.3B to investors through dividends and share repurchases during the quarter and completed over $186B of the capital return program Declared cash dividend of 57 cents per share
I.
iPhone Product Cycle has Matured
The iPhone product cycle has matured reaching its peak with unit sales of 74.5M (+46% y/y) in F1Q15 when the iPhone 6 was released to a huge pent-up demand from the iPhone 4 and iPhone 5 installed base (see Figure 1). By F1Q16 with the release of the iPhone 6s, sales plateaued at 74.8M units and growth rate was flat. Since then, comps for the last 3 quarters have been negative. F1Q17 will be the first full quarter of iPhone 7 sales. We are projecting sales of ~70.3M units, a growth rate of minus 6% y/y.
1
VIOLA ADVISORY, LLC
11/01/16
FIGURE 1: iPhone Unit Sales (Million Units) and Y/Y Growth (%) 74.5
80.0 70.0 60.0
74.8
46% 61.2
51.0
50.0 40.0 30.0
40%
35% 49.6
47.5
43.7 17% 39.2 35.2 16% 13%
70.3
With iPhone growth rates stalling, Apple needs another new product that can generate the same amount of buzz as the iPhone. iPhone sales contribute ~60% of total revenue (see Table 2). However, with the decline in unit growth rates over the last 3 quarters, iPhone revenue growth rates have also fallen dramatically from -13% y/y last quarter to -23% and -18% in F3Q16 and F2Q16 respectively (see Table 2).
50% 40% 30%
51.2
27%
40.4
45.5 20% 10%
7% 0%
20.0
0% -6% -8% -10%
10.0
-16% -15%
0.0
Units
-20%
Y/Y chg.
Source: Apple, Inc.; Note: F1Q17 unit sales are Viola Advisory LLC estimates
TABLE 2: Product Revenue Breakdown (Units and Revenue in Million, Y/Y % Change)
Y/Y Change F4Q16 % of F4Q16 F3Q16 F2Q16 Units Revenue Total Units Revenue Units Revenue Units Revenue
iPhone
45,513
$28,160
iPad
9,267
$4,255
Mac
4,886
$5,739
12% -14%
$6,325
13% 5%
Services Other Products
$2,373
Total
$46,852
60%
-5%
9%
-6%
Source: Apple, Inc.
-13% -15%
-23% -16%
-18%
-9%
7% -19%
-19%
-17% -11%
-13% -12%
0% 24%
19%
-22%
-16%
30%
-9%
-15%
-13%
II.
-9% 20%
At the last earnings call, management mentioned the strong growth in Service revenue, up 24% y/y. But Services are only a small segment, making up 13% of total revenue in F4Q16.
Profit Margins Resilient Despite iPhone Revenue Decline – For How Long?
FIGURE 2: iPhone Y/Y Revenue Growth and Net Income Margin (%) 51% 55% 34% 36% 22% 22% 21% 20% 24% 23% 22% 22% 24% 21% 18% 19% 13% 9% 1%
-9% iPhone Rev. Source: Apple, Inc.
NIM
-18%
-13%
Despite flat to declining iPhone revenue growth over the last 4 quarters, Apple’s net income margin has largely been stable (Figure 2). For example, when iPhone revenue growth dropped from 36% y/y in F4Q15 to 1% y/y in F1Q16, NIM increased by 200 bps, from 22% y/y to 24% y/y, during the same period. Moreover, despite steep drops in revenue growth over the past 3 quarters, NIM has largely been stable at ~19%. This is likely due to the growth of Services, which is a high-margin business and therefore contributes more to Apple’s bottom line.
2
VIOLA ADVISORY, LLC
11/01/16
FIGURE 3: iPhone Average Selling Price ($) $690 $649 $643 $595 $619 $556
$687 $658
$605 $595 $560
Despite the incremental add-on features of newer iPhone models, ASPs have been stable for the most part (see Figure 3). This is due to the large installed base of iPhone users who remain loyal to Apple products. However, last quarter’s ASP increase to $619 from $595 was not high enough to grow ASP on a y/y basis. ASP declined in F4Q16 by minus 5% y/y. Management stated that next quarter’s ASP will likely strengthen markedly to the same level as F1Q16 (or $690). We are projecting next quarter ASP to be ~$658, a negative growth rate of -5% y/y.
Source: Apple, Inc.
We believe that over time, Apple’s pricing power will decline as: 1) commoditization of the smartphone industry continues, 2) the influx of lower-cost Chinese smartphone makers enter the U.S. and Western markets exerting more downward pressure on ASPs, and 3) the decline in consumer perception of Apple’s premium brand image due to the lack of innovative products in its pipeline.
III.
Losing Momentum in China
China used to be the stellar growth market for Apple. But in the last earnings call, CEO Tim Cook did not mention China in his prepared remarks, instead he talked about the tremendous growth potential in India. China has been a disappointment during the last three quarters as sales have dropped by -30% y/y (F4Q16), -33% y/y (F3Q16) and -26% y/y in F2Q16 (see Table 3). TABLE 3: Revenue by Geography ($ Million) and Y/Y % Change The good news is that Apple managed to slow the sales decline in the Americas region 20,229 43% -7% -11% -10% and Europe seems to have strengthened Europe 10,842 23% 3% -7% -5% considerably last quarter. While it’s still too Greater China 8,785 19% -30% -33% -26% early to tell how sales of the iPhone 7 will perform in Europe and the Americas, we Japan 4,324 9% 10% 23% 24% believe the iPhone 7 is much too little too APAC 2,672 6% -1% -20% -25% late to stem the loss of market share in Total 46,852 -9% -15% -13% China. Local manufacturers like Xiaomi and Source: Apple, Inc. Huawei are producing much cheaper smartphones that almost have the same distinct look and feel as the Apple iPhone – and Chinese consumers seem to prefer them over the iPhone. Americas
F4Q16
% of Total
F4Q16
Y/Y Change F3Q16 F2Q16
3
VIOLA ADVISORY, LLC
11/01/16
Disclosure Information Analyst Certification The authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect their personal views about any and all of the subject securities or issuers; (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this report; and (iii) no insider information/non-public price-sensitive information in relation to the subject securities or issuers which may influence the recommendations were being received by the authors. Disclaimer By accepting this report (which includes any attachment hereto), the recipient hereof represents and warrants that he is entitled to receive such report in accordance with the restrictions set forth below and agrees to be bound by the limitations contained herein. Any failure to comply with these limitations may constitute a violation of law. This report is strictly confidential and is for private circulation only to clients of Viola Advisory, LLC. This report is being supplied to you strictly on the basis that it will remain confidential. No part of this report may be (i) copied, photocopied, duplicated, stored or reproduced in any form by any means or (ii) redistributed or passed on, directly or indirectly, to any other person in whole or in part, for any purpose without the prior consent of Viola Advisory, LLC. Viola Advisory, LLC, its affiliates and related companies, their directors, associates, connected parties and/or employees may own or have positions in securities of the company(ies) covered in this report or any securities related thereto and may from time to time add to or dispose of, or may be interested in, any such securities. The information contained in this report is prepared from publicly available data and sources believed to be correct and reliable at the time of issue of this report. This report does not purport to contain all the information that a prospective investor may require and may be subject to late delivery, interruption and interception. Viola Advisory, LLC does not make any guarantee, representation or warranty, express or implied, as to the adequacy, accuracy, completeness, reliability or fairness of any such information and opinion contained in this report and accordingly, neither Viola Advisory, LLC nor any of its affiliates nor its related persons shall not be liable in any manner whatsoever for any consequences (including but not limited to any direct, indirect or consequential losses, loss of profits and damages) of any reliance thereon or usage thereof. This report is general in nature and had been prepared for information purposes only. It is intended for circulation amongst Viola Advisory, LLC’s clients generally and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. The information and opinions in this report are not and should not be construed or considered as an offer, recommendation or solicitation to buy or sell the subject securities, related investments or other financial instruments thereof. The views, recommendations, advice and opinions in this report may not necessarily reflect those of Viola Advisory, LLC or any of its affiliates, and are subject to change without notice. Viola Advisory, LLC has no obligation to update its opinion or the information in this report. Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investment objectives, financial situation and particular needs and consult their own professional and financial advisors as to the legal, business, financial, tax and other aspects before participating in any transaction in respect of the securities of company(ies) covered in this report. The securities of such company(ies) may not be eligible for sale in all jurisdictions or to all categories of investors. Risk which may impede the achievement of our Price Target This report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, the financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of the financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, and income from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financial and political factors. If a financial instrument is denominated in a currency other than the investor’s home currency, a change in exchange rates may adversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities such as ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk.
4
