In this article I will analyze Apple's growth performance since the first quarter of FY2011, why earnings growth will most likely turn negative in the current quarter and the ways in which Apple will begin to return to stronger rates of revenue and earnings growth as early as the June quarter of the current fiscal year. Apple's "March Quarter Madness" is the beginning of the end of a cycle of lowered rates of growth.
Apple's Revenue and EPS Growth Rates
The graph below illustrates Apple's rates of revenue and earning per share growth since FQ1 2010.
The graph below illustrates Apple's rates of revenue and earning per share growth since FQ1 2010.
Since FQ3 2012, Apple's rate of year-over-year earnings per share growth has fallen below the rate of revenue growth. This trend will continue through the March quarter due to the extraordinary high gross margin achieved in the first half of last fiscal year.
Apple's Gross Margin Performance
The Graph below illustrates Apple's gross margin performance since FQ1 2010.
It's not a coincidence Apple's gross margin reached extraordinary high levels in the first six months following the release of the iPhone 4S. The iPhone 4S is the second handset in the iPhone 4 series and delivered record gross margin due in part to Apple's ability to apply the fixed costs of iPhone 4 series production over a much larger number of units sold.
In the recent December quarter (FQ1 2013), the first full quarter of iPhone 5 sales, Apple's gross margin outcome was nearly identical to the outcome in FQ1 2011, the first holiday quarter of sales for the iPhone 4 handset. Looking forward, Apple's gross margin performance will improve following the release of the second iPhone 5 series handset. Economies of scale on iPhone 5 series handset production will improve dramatically as the next iPhone 5 series handset finds its way to market. The trend is vividly displayed in the graph above. The first full quarter of release of the iPhone 4 handset (FQ4 2010) represents the low point for gross margin over a more than three-year period.
Apple's Gross Margin Versus Guidance
In the graph below I overlay Apple's gross margin outcome versus guidance since FQ1 2011.
At no time during this nine-quarter period has Apple's gross margin guidance been within 125 basis points of the actual outcome. However, management's gross margin guidance provides insights into management's view of the current gross margin trend. For the March quarter, management has guided to gross margin of between 37.5% and 38.5%. In the recent December quarter, the difference between gross margin guidance of 36% and the outcome of 38.63% was 263 basis points. Adding 200 basis points to the low end of the March quarter gross margin guidance range yields a gross margin estimate of 39.5%.
In the March quarter one year ago, gross margin reached a peak of 47.37%. The dramatic year-over-year drop in the current quarter's gross margin performance will deliver negative net income growth for the first time in the company's recent history.
Apple's Revenue Versus Guidance
In the graph below I compare Apple's revenue guidance over the most recent nine fiscal quarters.
Apple's Revenue Versus Guidance
In the graph below I compare Apple's revenue guidance over the most recent nine fiscal quarters.
Since FQ3 2012 management's revenue guidance has been a fairly accurate forecast of the company's revenue outcome. In the recent December quarter, revenue was 4.83% above guidance at $54.51 billion.
For the March quarter, management has guided to revenue of between $41 billion and $43 billion. I expect revenue in the current quarter to slightly exceed the top range of guidance. This will represent the slowest rate of quarterly revenue growth in the company's recent past.
Unit Sales Growth By Device Line
The graph below illustrates the dramatic drop in unit sales growth across all of Apple's major device lines.
Following the March quarter one year ago (FQ2 2012), the iPhone, iPad and Mac device lines have experienced dramatic slowdowns in the rates of unit sales growth. The delay in delivery of the recently refreshed iMac line of personal computers pushed Macintosh unit sales growth to a negative 22% in the December quarter. Expectations of the release of the iPad mini reduced unit sales growth of the entire iPad line to a meager 26% in the September quarter (FQ4 2012).
Impacting year-over-year unit sales growth across all product lines in the December quarter was the 14-week prior-year quarter (FQ1 2012) versus the usual 13-week quarter in FQ1 2013. Constrained supplies of the iPhone 4S at the end of FQ1 2012 boosted reported iPhone unit sales in the March quarter last year.
The delay in delivery of the new iMac computers into the March quarter and Apple's satisfactory fulfillment of pent-up demand for the refreshed product line will contribute to results at or above the top range of revenue guidance this quarter.
Greater China and Japan are Apple's two fastest growing revenue regions. Neither China's biggest carrier (China Mobile) or Japan's biggest carrier (NTT DoCoMo) currently offer the iPhone to subscribers. Apple's slowing rate of geographic expansion and the lack of significant carrier additions over the past nine months have contributed to the slow rate of revenue growth since FQ2 2012. In that quarter China Telecom was added as an authorized iPhone carrier.
The iPhone became available on Verizon in February 2011 and Sprint was added as an authorized carrier for the iPhone later that year following the release of the iPhone 4S. Strong demand for the successor to the iPhone 5 is expected in the first two quarters following release of the new flagship handset. But carrier additions are needed to boost iPhone unit sales growth well above 50% in future quarters. The global smartphone market is maturing rapidly. Apple will achieve much higher gross margin following the release of the second handset in the iPhone 5 series. But carrier expansion coupled with geographic expansion are essential for sustaining strong rates of unit sales growth for more than the two quarters following the release of the next flagship iPhone handset.
The Apple iPad line has emerged from its nascent phase of global market development. The so-called Retina display iPads (iPads 3 & 4) appear to be transitional releases as Apple engineers longer battery life and lighter enclosures. Consumer expectations of pending iPad refreshes will dampen the rates of growth in unit sales until the release of successor models. The popular iPad mini has driven down ASPs for the iPad line and expectations for a higher resolution display for the diminutive iPad suggest demand is already building for the next iPad mini models.
Apple's Average Selling Prices
The graph below illustrates Apple's average selling prices by device line over the most recent nine fiscal quarters.
The good news for Apple is iPhone ASPs have remained constant and Macintosh ASPs have improved over the past two quarters. The influence of the iPad mini has driven average selling prices for the product line from a high of $606 in FQ3 2011 to a low of $467 in the recent December quarter. I expect iPad ASPs to remain under $500 for the foreseeable future as the rate of iPad mini unit sales growth exceeds the rate of unit sales growth for the larger iPad models.
The recently refreshed iMac line and Apple's ability to meet demand for the new personal computers will boost the Mac line's ASPs through the balance of the fiscal year. A major refresh of the Mac Pro line of workstations is long overdue. Although the Mac Pros do not have nearly the unit sales volume of Apple's iMac and portable lines, Mac Pros have an overall positive impact on ASPs of the entire Macintosh line. A major upgrade of the Mac Pro line is expected by the end of the fiscal year.
Apple's ability to maintain high ASPs on the iPhone line flies in the face of conventional wisdom. The rapidly maturing global smartphone market will result in increasing pressure on handset prices as more commodity-grade product enters the market. Because iPhones use Apple's proprietary iOS and device owners benefit from the quality and array of content and services available through the iOS eco-system, the company can more easily differentiate its products in the global marketplace. Whether or not management chooses to expand the iPhone product line to address the needs of consumers in emerging markets and budget-minded consumers in the US and Europe is one of the biggest questions to be answered over the next nine months.
iTunes and The Apple Eco-System
Concurrent with the release of December quarter results, Apple changed its reporting on device sales revenue and separated revenue from the sales of accessories and services from device revenue.
The graph above illustrates average selling prices per device line using the recently revised numbers. The graph below charts revenue from Apple's recently revised revenue segments called iTunes/Software/Services and Accessories.
Apple has more than one-half billion iTunes accounts backed by credit cards. The revenue segment inclusive of iTunes continues to generate impressive rates of year-over-year growth. The number of iOS devices in active use increases by the day and the expansive eco-system of apps, content and services evidences an expanding number of users. Although the company's overall rates of revenue growth have dramatically declined over the past nine months with a sluggish rate of revenue growth expected in the March quarter, consistently strong rates of revenue growth in the revenue segment inclusive of iTunes suggests the overall eco-system remains economically vibrant.
Conclusions
The past six months has been a maddening time for Apple shareholders. The share price has fallen from an all-time high of $705.07 on September 21, 2012 to a closing price of $461.91 on March 22, 2013. The all-time high occurred about six months after the conclusion of a multi-year cycle of extraordinary rates of revenue and earnings growth. The recent 52-week lows are occurring just under a year following the slowdown in the rates of revenue and earnings growth.
The March quarter will most likely represent the low point in revenue and earnings growth in this multi-quarter cycle of reduced rates of growth with the current quarter delivering negative net income growth for the first time in the company's recent history.
Apple's March quarter madness will mark the beginning of the end of this maddening period for shareholders. Apple's gross margin will recover beginning with the March quarter and return to greater than 40% gross margin as early as the June quarter. The release of the successor to the iPhone 5 and economies of scale achieved with two iPhone 5 series handsets in the market will deliver stronger rates of earnings growth in the latter half of this calendar year and the first half of calendar year 2014.
The pace of Apple's geographic expansion and the timetable for the addition of China Mobile and NTT DoCoMo as authorized iPhone carriers are among the biggest questions to be answered by management at this time. Share price recovery will follow a return to earnings growth and the building of market confidence in the company's ability to sustain stronger rates of earnings growth through at least the first half of calendar year 2014. Earnings growth and earnings growth alone will drive the share price appreciably higher.
This maddening period for shareholders will end following Apple's March quarter madness. This will be the first and last quarter of negative net income growth for the foreseeable future.
Robert Paul Leitao
Disclosure: The author is long Apple shares
