Like last quarter, Apple set another record for revenue in its first quarter of 2014. However, margins at Apple have receded, turning year-on-year profit comparisons negative for yet another quarter. Earnings per share are up because of stock buybacks. But Apple shares fell 8% after the earnings were released. Apple continues to try to maintain margins as high as possible without sacrificing share. This strategy means contraction in the Americas. But Apple is betting on Asia for growth.
My macro thesis regarding Apple has been that Apple as a well-run company which executes its vision quite well, will continue to be a cash machine. But the company will be limited in terms of growth opportunities by its one company, one hardware seller, one operating system motif. The onslaught from the Android ecosystem has overwhelmed Apple in terms of market share. And this will take a toll on Apple in terms of margins and growth. So far, this is indeed what has happened and I expect this dynamic to continue to play out. Nonetheless, while I have expected 2014 to be the first year that Apple sees declining iPhone sales, Apple’s China strategy could prevent this.
There is a growing perception in the analyst community that follows Apple that the company is not innovating. There have been no breakthrough products in recent years. And new products have simply been incremental changes of previous products. This product strategy is vulnerable to price undercutting from Android. So new products are going to be a big issue for Apple this year.
Below are the headline numbers for Q1 2014:
- Revenue: $57.6 billion vs. $54.5 billion in Q1 2013 and $37.5 billion in Q4 2013 and forward guidance between $55 billion and $58 billion
- Profit: $13.072 billion vs. $13.078 billion in Q1 2013 and $7.5 billion in Q4 2013
- Gross Margin: 37.9% vs. 38.6% in Q1 2013 and forward guidance between 36.5 and 37.5%
- EPS: $14.50 vs $13.81 in Q1 2013
This was the fourth straight decline in profits at Apple and the eighth straight decline in gross margins. It was also the first annual profit decline in more than a decade. This is what I had predicted last January. EPS is up though and revenue is at record levels. However, shares fell because Apple missed some revenue estimates and analysts were disappointed with guidance. For example, before the news was released, Forbes reported that, “the consensus estimates among the 47 Apple analysts we’ve heard from so far — 29 Wall Street professionals and 18 Internet amateurs — are for earnings of $14.36 per share on sales of $58.1 billion. That represents year-over-year growth of 4.0% for earnings and 6.6% for revenue.” But, according to Reuters, analysts estimated that Apple would post EPS of $14.07 on revenue of $57.5 billion.
On product sales, Q1 2014 numbers came in as:
- iPhone sales: 51 million vs. 47.8 million in Q1 2013 and 33.8 million in Q4 2013
- iPad sales: 26 million vs. 22.9 million in Q1 2013 and 14.1 million in Q4 2013
- Mac sales: 4.8 million vs. 4.1 million in Q1 2013 and 4.6 million in Q4 2013
- iPod sales: 6.0 million vs. 12.7 million in Q1 2013 and 3.5 million in Q4 2013
Analysts had been expecting better on iPhones at 54 to 56 million iPhones. But Apple beat the 25 million iPads estimate and the 4.6 million Macs estimate. The key here is growth. From Q1 2012 to Q1 2013, iPhone sales increased 29.5%. iPads sales increased 48%. The year-over-year comparisons this time were less favourable: iPhone sales growth of 6.7% and iPad sales growth of 8.4%. iPod sales declined a massive 55%. Basically growth is dead at Apple. This is why the company is under pressure to return cash to shareholders before it wastes the cash for mergers or in chasing growth.
The good news on growth is Asia. While revenue fell in the America’s and grew only 5% in Europe, Apple recorded over $8.4 billion in sales in China alone, that’s up 29% from Q1 2013. Considering that Apple gets 64% of its revenue from abroad, it is good to see the positive results in China. Revenue in Japan was also up 11%. In the past, I have noted that Apple’s pricing strategy is not tailor-made for emerging markets like China. But this quarter proves there is growth for Apple in those markets. How much of this is a base effect and a result of the China Mobile deal remains to be seen. In any event, the average selling price of an iPhone was $637 in the latest quarter, down slightly from $642 in Q1 2013 and up from $577 in the last quarter. Those are high but declining numbers.
Apple is providing the following guidance for its fiscal 2014 second quarter:
- Revenue: $42 billion to $44 billion
- Gross margin: 37 percent to 38 percent
- Operating expenses: $4.3 billion to $4.4 billion
- Other income: $200 million
- Tax rate: 26.2%
I think this was a decent quarter for Apple. Last earnings period I said that I expected to see iPhone sales decline in 2014. But the China Mobile deal and the growth in China makes that a contentious prediction. The huge slowdown in Apple’s growth is behind us now. And the shares have adjusted to this new reality. Going forward, there is much less pop in Apple shares. It is no longer a growth company. Instead, now it is more of a barometer of the mobile landscape.