Summary: Apple set another record for revenue in its fourth quarter of 2013 according to its latest earnings. However, margins at Apple have receded such that profit fell for yet another quarter. Overall, Apple’s strategy now seems to be geared toward maintaining margins as high as possible without sacrificing too much share. It will be a difficult proposition despite Apple’s stellar execution.
I am still in the midst of digesting the flurry of Apple earnings analyses but the overall pattern is consistent with my macro theme regarding margin pressure at Apple. The company always executes well on its strategy and I see this quarter in the same vein despite the fall in profit. I would note that Apple’s addition of the luxury retailer CEO Angela Ahrendts to its executive team, tells you that Apple still has no intention of moving down market as a brand. Its goal therefore is to maintain the premium brand while ceding as little market share as possible. I believe the margin pressure is too great to overcome and I anticipate we will continue to see margin erosion as Apple fights against share loss with a lower margin product mix.
The case against Apple is still the same one I laid out at this point last year as the shares began to collapse: Apple cannot maintain earnings growth with the existing product palette given the competition from Android. The share collapse, however, seems to be behind us for now. With Apple returning cash to shareholders via buybacks, this will prop up earnings per share and the share price. Even so, I do not see Apple outperforming the market from here.
Below are the headline numbers for Q4 2013:
- Revenue: $37.5 billion vs. $36.0 billion in Q4 2012 and $35.3 billion in Q3 2013 and forward guidance between $34 billion and $37 billion
- Profit: $7.5 billion vs. $8.2 billion in Q4 2012 and $6.9 billion in Q3 2013
- Gross Margin: 37% vs. 40.0% in Q4 2012 and forward guidance between 36 and 37%
- EPS: $8.26 vs $8.67 in Q4 2012
This was the third straight decline in profits at Apple and the seventh straight decline in gross margins. So Apple is seeing earnings contractions just as I predicted in January. I think analysts have adjusted to this new world as average estimates on Wall Street were for $36.8 billion on the top line and $7.93 billion in profit. So Apple beat on both fronts. However, analysts are a bit disappointed about sales of Apple’s new budget phone the iPhone 5c.
On product sales, Q4 2013 numbers came in as:
- iPhone sales: 33.8 million vs. 26.9 million in Q4 2012 and 31.2 million in Q3 2013
- iPad sales: 14.1 million vs. 14.0 million in Q4 2012 and 14.6 million in Q3 2013
- Mac sales: 4.6 million vs. 4.9 million in Q4 2012 and 3.8 million in Q3 2013
- iPod sales: 3.49 million vs. 5.3 million in Q4 2012
In my view, there is weakness throughout these numbers because profit is declining and iPhone 5c and iPad product numbers are weak. The overall picture is one of declining margins, weak sales volume growth and therefore weak future earnings growth prospects. Apple’s swag of maintaining premium pricing while protecting share is not going to work. Average selling price in the iPhone segment continues to fall. After last quarter’s record low $581 average selling price, this quarter’s ASP came in even lower at $577 per device. In Q2, just two quarters ago, this number was $613. Yet, Strategy Analytics has estimated that Apple’s market share for mobile handsets continued to fall to 13.4% in the quarter ended in September versus 15.6% in the previous quarter. This is why I wrote after the last earnings release that the focus has turned to returning cash to shareholders.
Guidance for Q1 2014 is as follows:
- Revenue: $55 billion – $58 billion
- Gross Margin: 36.5% – 37.5%
The rubber hits the road at pricing for Apple, given the increasingly cut-rate pricing of major competitors. Last year, when the iPad Mini was introduced I wrote a post saying the iPad Mini was too expensive. Subsequently, what we have seen is sales volume contraction in the iPad segment of the market. And I believe this is due to Apple’s decision to protect margin and remain premium-priced in the face of stiff competition. This year, the iPhone 5c is just like the iPad Mini last year. It is too expensive, particularly for emerging markets like China where incremental growth for Apple will come. Apple will begin to see sales growth problems in its core iPhone segment in my view, due to its adherence to a premium brand, premium price strategy in the face of competition from Android and elsewhere. As Apple tends to execute well, we may not see this problem in Q1 2014 numbers but by the end of 2014, I expect iPhone sales volumes to contract.
I will leave it there for now. There is more to come at a later point.