The bottom (and top line) for Apple, Inc. (NASDAQ:AAPL) comes down to success in iPhones. The 51 million number for the first quarter was disappointing versus consensus view of 54 million as Apple is facing saturation in its home market.
The 1 percent decline in US revenue and the slight decline in Verizon activations do suggest maturity is an issue. The company thinks developed markets still can grow, but it is unlikely unless it brings new and disruptive products to the market.
The March quarter forecast also remained weak with Apple guiding revenue to $42 billion - $44 billion, lower than the consensus view of $46.0 billion. After such weak guidance for the March quarter, and the usually too optimistic tendencies of the sell side, one can't help but raise the issue of June-quarter revenue. Wall Street expects June quarter revenue of $39.91 billion.
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BMO Capital Markets analyst Keith Bachman estimates June-quarter revenue to decline by over 16 percent sequentially versus the average sequential decline of 15 percent over the past two June quarters. China Mobile could help some for the March and June quarters, though Apple may not launch the new large screen iPhone until after the June quarter.
Apple pointed to more stringent upgrade policies in the US causing some purchase deferrals for a couple quarters and greater 5s demand than expected that caught Apple short until quarter's end. The less-generous upgrade policies are likely to persist for the next several quarters, and then anniversary in the December 2014 quarter.
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Moreover, investors should accept the fact that Apple have not created a meaningful new product category with the iPhone 5c that has a high price of $549. The strategy of giving more importance to margin above volumes may hurt Apple's plans for emerging markets such as China and India.
Bachman thinks Apple needs to create a more impactful "medium" price iPhone, presumably with a lower price than the current $549 unlocked price.
In addition, Apple said that channel fill in the December quarter is negatively impacting March quarter revenue growth sequentially. This argument is questionable as it implies that the December quarter was not as good as it looked.
If one eliminates $2 billion of revenue from the December quarter, then this would suggest the company sees March quarter revenue to declining by 22 percent sequentially compared to 20 percent last year.
iPhone inventory grew by 1 million and iPad by 1.4 million in the March quarter a year ago, which Apple points out makes the sell-in comparisons difficult this March. That is true for iPad, but the other side of the story is that iPad inventory grew 2.1 million units in the just-reported quarter.
UBS analyst Steven Milunovich agrees that the 1 million inventory build last year does make the comparison a bit harder, but in the March quarter of 2012 iPhone inventory was up 2.6 million units sequentially and in March of 2011 up 1.7 million, which were much tougher compares.
Another way to think about it is considering the inventory build over the product cycle. Apple's channel inventory should grow as it adds carriers, its own stores, and expands its third-party network. Throughout the iPhone 4s cycle, Apple increased its channel inventory by 2.4 million units as it added 22 carriers, 32 retail stores, and grew its distribution network.
The analyst noted that the iPhone 5 cycle witnessed a similar dynamic with notable additions in China, but the company also compressed its international roll-out to just 2-3 months and thus built inventory sooner in the cycle.
In just two quarters, the iPhone 5s/5c cycle has resulted in the largest increase in channel inventory with 4.3 million additions. This makes sense considering the sizable additions related to China Mobile and NTT DoCoMo. Additionally, the company rolled-out the new devices simultaneously, prompting an earlier ramp.
Considering the magnitude of these new additions, further increases seem reasonable, though management indicated a sell-in headwind of at least $1 billion in revenue.
At the end of the day, iPhone demand still appears disappointing. Going forward, growth in emerging markets could be a bright spot. Growth in the December quarter was 76 percent in Latin America, 65 percent in the Middle East, 115 percent in Eastern Europe, and 20 percent in China.
China remains the biggest catalyst for Apple as it may ramp more slowly than hoped because Apple only is selling in 16 cities currently. As we said earlier, Apple should sell its products at competitive prices in emerging markets to generate more sales.
Milunovich says he doesn't care that Apple is losing share as most growth occurs at low price points where Apple should not play, but he emphasized that the company still needs solid double-digit gains where demand is strongest.
However, the high-end smartphone market is maturing quickly, with industry revenue growth likely to slow from here and increased competition likely as the industry searches for the innovation to drive it higher. Smartphone unit growth is likely to continue into lower price points, with significant ramifications for industry participants.
CEO Tim Cook did say that a new product category would be introduced this year. Apple mentioned iBeacon and potential in payments; wearables are expected, although, its timing is uncertain.
As of now, disappointing iPhone units create a near-term headwind, and earnings and revenue growth with new products (iPhone 6) would be a second half catalyst. Cook said Apple has plenty of disruptive ideas but needs to concentrate resources on the best opportunities, but the results from those initiatives may be visible only in the latter half of the year.
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Meanwhile, if any person is optimistic on Apple in this situation it is none other than Carl Icahn, who bought another $500 million shares, bringing his Apple holdings to roughly $4.1 billion.
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