Apple Reports Another Decline in iPhone Sales, Stock Rallies Anyway

Shares of Apple Inc. rally over 7% in afterhours trading on a beat of lowered earnings expectations.

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Peak Apple? Probably not yet.

The Apple Inc. third quarter earnings release reported another year over year decline in earnings and revenues after the closing bell today. The company posted quarterly revenue of $42.4 billion and quarterly net income of $7.8 billion, or $1.42 per diluted share. These results compare to revenue of $49.6 billion and net income of $10.7 billion, or $1.85 per diluted share, in the year-ago quarter. Gross margin was 38% compared to 39.7% in the year-ago quarter. International sales accounted for 63% of the quarter’s revenue. 

Earnings, down 23% year over year, beat the Wall Street consensus estimate of $1.38/share by 4 cents/share. Revenues, down 14.5% year over year, beat Wall Street's consensus estimate of $42.1 billion by $300 million. Apple's results were not great, but they were not as bad as many bears had expected. The midpoint of the company's guidance for Q4 revenue came in above Wall Street's consensus estimate of $45.8 billion by $700 million. The stock is up over 7% in afterhours trading on the back of these better than expected results.

It is not all apple sauce for shareholders today, as the company reported year over year decreases in unit sales of iPhone, iPad, Macs, and other products (Apple TV, Apple Watch, Beats products, and accessories). One standout in the Q3 results was the Services segment with year over year 19% sales growth. Services is now the second largest revenue segment at Apple Inc., with Q3 revenue of $5.9 billion. This operating segment includes Internet Services, Apple Pay, and App Store.

Another interesting data point is that while iPad experienced a 9% decline in year over year unit shipments, the product segment was able to grow revenue at 7% on higher average selling prices. This is most likely attributable to customers upgrading to higher priced iPad Pros. The iPhone segment experienced the opposite phenomenon as unit sales dropped 15% year over year while revenue dropped 23% on lower average selling prices of the smartphone, likely the result of the launch of iPhone SE that ramped up during the quarter. This is the second consecutive quarter that Apple Inc. has reported year over year declines in iPhone sales and company-wide revenues. iPhone represented 56% of Apple's revenues in the quarter.

Macintosh sales only make up 12% of Apple's revenues, and were down 13% year over year. Mac appear to be slowing more rapidly than the broader PC industry. We will know more as the rest of tech companies report their quarterly results, but this is a new trend that Apple Inc. needs to address with a more compelling lineup. They have not materially updated their flagship MacBook Pro line this year, and that could provide potential upside going into the end of the year.

Apple Inc. ended the quarter with $231.5 billion in cash, down $1.5 billion from $233 billion on the balance sheet at the end of Q2.  The company's cash hoard decreased for the first time in seven quarters. The company returned over $13 billion to investors through share repurchases and dividends in the quarter, and have now completed almost $177 billion of the ongoing $250 billion capital return program. Apple’s board of directors has declared a cash dividend of $.57 per share of the Company’s common stock. The dividend is payable on August 11, 2016 to shareholders of record as of the close of business on August 8, 2016.

Why is the stock up 7% on such mediocre news? I believe that investor sentiment had gotten too negative since the company lowered their guidance earlier this year. Wall Street was positioned for another flush to 52 week lows in the share price and when the results came in the bears had to cover their shorts. I believe that we are in a period similar to 2004-6 for Apple Inc. In those days, iPod represented more than 65% of revenues and many bears claimed that we were witnessing "Peak Apple." Our own Chatty community had a discussion about this just last week.

"I'm not saying apple will go away so much as I'm saying we have hit peak apple" - bradsh, Chatty user.

Most of the media is claiming that Apple's best days are behind it as iPhone sales are slumping. Others pile on the negativity saying that the company has yet to prove they can innovate without Steve Jobs. Apple Inc. has a history of introducing a new product category as another one matures. It is easy to claim we have witnessed "Peak Apple" after 9 years of iPhone sales growth, but it may be just as misinformed of a statement as those who claimed the company was peaking when iPod demand peaked. Peak iPhone? Maybe. 

Peak Apple? I doubt it. The company is opening their brand new space ship campus next year. This was a project introduced by Steve Jobs just a few months before his passing. A project introduced in 2011 that will not be completed until 2017. This is the pace at which Apple does business. Steve Jobs began conceptualizing the iPad as early as the 1980s, prototyping began in the early 2000s, and the product ultimately launched in 2010. Apple bulls believe that there were multiple things left in the pipeline before his passing. Steve Jobs famously told Walter Isaacson that he "cracked the code" in television, and we have yet to see Apple Inc. or anyone else truly disrupt the product category.

Faith is not an investment strategy, but it is required to believe that there is material upside to Apple's stock. Investors have to believe that there is another product category that can spur revenue growth at the company. Otherwise, declining average selling prices and margins will erode Apple's profitability and ulimately lead them into a lost decade similar to the 2000s for Microsoft.

Apple is investing in new products. Research and Development expenses are at their highest level in history and there are rumors continuing to swirl about an electric vehicle project. Tim Cook praised Pokemon Go on the conference call and reaffirmed that Apple will continue to invest in AR. With the amount of cash at their disposal, I wouldn't bet against Apple right now.

2016 will undoubtedly be a forgettable year for Apple, but it remains to be seen which way the company's fortunes will bounce from this inflection point. At the end of the day, the stock trades at a discount to its peers and the S&P 500. It is one of the worst performers in the Dow Jones Industrial Average this year and revenues continue to decline. It is completely understandable to think that the company's best days are behind it, but they are generating huge cash flows from a dedicated user base.

I will continue to stay invested in the stock, which I have owned since 1997. The stock trades at 11 times forward earnings estimates and pays investors a 2.3% dividend yield to wait and see if their faith is founded in logic or just a foolish desire for one more thing.

Full Disclosure:

At the time of this article, Asif A. Khan, his family members, and his company Virtue LLC had the following positions:

Long Apple Inc. via AAPL common stock and options

Asif Khan is the CEO and majority shareholder of Shacknews. He began his career in video game journalism as a freelancer in 2001 for Tendobox.com. Asif is a CPA and was formerly an investment adviser representative. After much success in his own personal investments, he retired from his day job in financial services and is currently focused on new private investments. His favorite PC game of all time is Duke Nukem 3D, and he is an unapologetic fan of most things Nintendo. Asif first frequented the Shack when it was sCary's Shugashack to find all things Quake. When he is not immersed in investments or gaming he is a purveyor of fine electronic music. Asif also has an irrational love of Cleveland sports.

From The Chatty

  • reply
    July 26, 2016 4:05 PM

    Asif Khan posted a new article, Apple Reports Another Decline in iPhone Sales, Stock Rallies Anyway

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      July 26, 2016 4:06 PM

      No can defense.

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      July 26, 2016 10:33 PM

      Everyone is saying that the next iPhone is the 6SE and not 7 too. That'll probably hurt sales as well since it's not a major revision. If true anyway.

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      July 27, 2016 12:21 AM

      LOL at the "peak apple" chatty quote included in the article.

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      July 27, 2016 12:21 AM

      The 6S was pretty lack luster for me; I'm going on two years with the 6. I'll buy whatever the 7 is.

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        July 27, 2016 5:42 AM

        I'm still on my 5s. I skipped the 6 generation because I thought i could hold out. My 5s has become a pain to use. I can lose 20% battery just driving to work on the morning. A lot of apps crash on loading. So yeah I don't even care what the 7 does better, I just want a new phone.

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          July 27, 2016 5:46 AM

          yeah my wife has a 5s and its turned into a real piece of garbage. Going to get her the 6s once it gets price cut or the 7 if its really amazing.

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          July 27, 2016 5:49 AM

          Same here. I've been holding out for awhile and the battery life is now garbage.

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            July 27, 2016 6:00 AM

            Make sure you don't have the Facebook app. Killing that will save you 15% to 20% battery a day.

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          July 27, 2016 5:59 AM

          Yikes, sounds like the hardware is going bad or something. I've got a 5S going strong still.

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          July 27, 2016 6:09 AM

          Same here. My 5s battery is crap after 2.5 years of use. But I'd rather replace the battery than shell out on a new phone at this stage, I don't feel like the SE represents a substantial upgrade.

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          July 27, 2016 6:21 AM

          I just took my sister's 5S to the store to replace the battery and it's like a new phone (well, minus the spotty performance, but she's not a power user).

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          July 27, 2016 6:24 AM

          My 5c works just fine.

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          July 27, 2016 6:28 AM

          This is pretty much how I determine it's time to upgrade. I'll pretty much run with a phone until it starts going funny on me. Don't see any point in replacing something that works properly.

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            July 27, 2016 6:42 AM

            I've always used phones until they become unusable. Especially in recent years as the technology leaps have become less about "oh I have to have that new feature" and more about a better camera / battery life. I can't really see where phone technology is going in say 5-10 years. My biggest wish is that they just focus more on the battery life and charge times. Heck, even if you can't get battery life longer, if you could have some hyper fast charging technology where in 5 minutes the phone is fully charged that would be a game changer.

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              July 27, 2016 6:59 AM

              Yeah I definitely would prefer a little thicker phone if it gives me good battery life. Plus little things like improving reception would be nice.

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          July 27, 2016 6:38 AM

          I tried that once, never again. I hope the 7 is something schnazzy because my 6plus is showing its age, and while it's more than fine & usable now, I can only imagine that another year and some months for the 7s or whatever is next will be excruciatingly painful.

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          July 27, 2016 7:04 AM

          I'm still using my 5s but I'm tempted to get the iphone SE to keep the form factor and also to stay compatbile with my iphone otoscope. I literally charge the phone any chance I get (in the car, at my desk, etc.). I have a lightning cable with me literally at all times like a leash, lol

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          July 27, 2016 7:13 AM

          That's weird, I'm still on a 5 and it works fine. The biggest issue I have with it is battery life at this point, but it still lasts the day with normal usage just fine. I also have an iPad Air 2 at home which is definitely faster, but it's not as noticeable as I would think it would be given how old the 5 is. I should really get an SE but I was disappointed they didn't include 3D touch on it so I just kind of... never bough one.

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            July 27, 2016 8:26 AM

            I'm definitely leaning towards the thing having hardware problems. It get's really hot when I play games or use navigation. The thing just eats battery.

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              July 27, 2016 8:51 AM

              Man, be prepared to have it replaced. If the battery is starting to overheat you're in danger of getting the iPhone 5 swelling battery issue. It pushed the screen out on my phone by about 1/2 a centimetre. Getting it replace today theoretically.

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            July 27, 2016 9:21 AM

            Hardware is a crap shoot.

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          July 27, 2016 9:23 AM

          We replaced my wife's 5 with an SE, and she loves it. Battery life is great too. It's a really nice little phone.

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          July 27, 2016 9:38 AM

          Go for the SE.

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          July 27, 2016 9:45 AM

          iPhone SE is the fucking bomb.

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          July 27, 2016 9:47 AM

          You should check out the SE, it's the same size as the 5s and a practically free upgrade.

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          July 27, 2016 9:47 AM

          I wish the batteries were replaceable. My HTC Incredible had a user-replaceable battery and it wasn't ridiculously huge. :/

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        July 27, 2016 7:29 AM

        If they move to a 3 year cycle with the 6 and we don't get a 7 this year, will you still upgrade? I'm on the fence.

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        July 27, 2016 9:19 AM

        Given all the rumours of the 2017 model, I might wait for that. Everything I've heard for this year's make it sound like a iPhone 6++

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      July 27, 2016 6:47 AM

      There's no way it keeps this up with phone sales slumping and the annual dip at product launch.

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      July 27, 2016 10:04 AM

      Made some excellent money on apple stock this morning. Went all in late afternoon yesterday, surprised that it jumped so quickly. Now I am all in on Delta Airlines!