Apple’s (NASDAQ: AAPL) earnings results for 1Q14 released yesterday, on initial review, were mixed. EPS and sales were ahead of consensus forecasts, but iPhone volumes and 2Q guidance fell short of Street expectations. This has led to a sell-off in the shares and a possible buying opportunity for those interested in looking at Apple long, since the core story essentially remained intact. If you liked it before the earnings for its market expansion, cash position and potential new product introductions, it’s even looking better at a lower price.
1Q14 Earning Report
Apple delivered EPS of $14.50 per share beating estimates by $0.41 with revenues of $57.59 billion also beating consensus by $130 million. Other key sales metrics included sales of 51 million iPhones, 26 million iPads and 4.8 million Macs, and year-over-year sales increased/decreased by 6%, 7% and -13%, respectively. The gross margin also was ahead of the guided range at 37.9%, but still down by 70 bps from the prior year’s result.
Management issued 2Q14 guidance of $42 – $44 billion, below the current consensus forecast of $46 billion. iPhone sales, 56% of total sales, of 51 million were disappointing compared with Street expectations of 56 – 57 million. The average ASP was $637 versus $577 in 4Q with iPhone 5s sales outpacing the iPhone 5c. That said, iPad sales were ahead of the top end of the Streets expected range by one million units. But the ASP was flat q/q at $440 compared with $439.
While sales in the Americas were down by 1% y/y, Europe was up by 5%, compared with flat growth in the prior quarter. Importantly, the Chinese market was up 29% this quarter versus 6% in the prior quarter. Management stated the launch with China Mobile last week was the best Apple has had to date for Chinese iPhone activations.
Japan was up just 11% y/y versus the 41% in the prior quarter. Sales in yen actually increased by 40% in the quarter, but the exchange rate resulted in a dramatic impact. The growth in Japan was driven by the launch of the iPhone by DoCoMo.
The weak guidance for 2Q14 and the iPhone sales shortfall are largely behind the selloff in the shares. Management states the below consensus guidance is due to channel inventory shifts. It went on to say that 2Q13 inventories rose due to shortages in 1Q13 creating a push of 1Q sales into 2Q. 1Q14 ended with inventory in balance with demand, and this will not occur again as a result since all demand in 1Q14 had inventory to meet it.
Changes to carrier policies also are acting as a headwind for iPhone sales and will continue to do so in the US. Previously, carriers were soft on their upgrade requirements but a new focus on cutting subsidies for phone purchases and upgrades, carriers are sticking to a policy required 24 months between upgrades.
Also noteworthy was a 32% y/y jump in R&D spending, a possible indication of new product developments. Cash was $159 billion at quarters end with 78% located offshore.
iPhone and Guidance Disappoint – US Smartphone Market Maturing
The biggest issue in the quarter was the shortfall in iPhone sales in the quarter. While management did explain part of this via a change in the upgrade cycle, alone it does not explain the flattish y/y guidance for 2Q given the addition of DoCoMo in Japan, T-Mobile and especially China Mobile. All of these are incremental. This may be a signal of slowing smartphone growth in the US. The market is becoming saturated with fewer and fewer making the switch to a smartphone and will rely more on upgrades for growth. With new carrier policies, this will likely lead to a flattening off of smartphone sales volumes in the US. Samsung (LSE: BC94.L) and Nokia (NYSE: NOK) could also feel the pain along with Google (NASDAQ: GOOG).
The higher ASP for Apple also may have had a negative impact on volume in 4Q. Apple is faced with choosing between margin and volume and it sided with the former this quarter.
New Markets and New Product Categories will Drive Growth
What did not change is Apple’s expansion into the more rapidly growing developing markets, China in particular. Also, Apple will benefit from the iPhone 6 refresh in the latter part of the year that should accelerate growth.
In addition, Tim Cook, Apple’s CEO, stated that it has no problem finding new categories it can disrupt, it is just picking the best ones to focus on. There are two areas in focus TV which has been widely discussed and mobile payments, the focus of a recent WSJ article. Other products of potential interest would be an iWatch but it lacks the potential of TV or mobile payments.
While the quarter was not great, it was not the disaster the selloff would indicate. The potential remains for continued geographic market expansion and the introduction of new product. Even mild success in a new product category would likely lead to upside in shares. The Street no longer views Apple as innovative and if this perception starts to change the multiple investors pay for Apple can expand.
What are your thoughts on the future of Apple?
John has seven years of experience as an equity analyst following various stocks and sectors. As a senior equity analyst, he received awards from the Wall Street Journal and Financial Times for his writing.