Quick Thoughts: AAPL – Awesome! Epic! When Should We Sell?

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–     AAPL sold 74.4M iPhones in its 1QF15, up 46% YoY and nearly 10M above consensus – with an ASP of $687, up 7.8% YoY – driving sales of $74.6B and EPS of $3.06, both WAY above expectations

–     The iPhone is now 68.6% of AAPL sales and likely, 80%+ of its profits – by far the biggest share ever. Mac joined the party, with units up 14.5%, but iPad units were down 17.7% with a lower ASP.

–     Guidance for 2QF15 sales of $52-55B is slightly above consensus. This is strong given FX headwinds and implies continued iPhone strength and initial Apple Watch shipments ahead.

–     The iPhone 6/6+ satisfied pent-up demand for bigger screens, pulling many upgrade sales forward. With the good news on the table and TOUGH compares ahead, we expect AAPL to crest soon

Apple delivered an epic blow out, besting even the most bullish analyst numbers. It sold 74.5M iPhones, crushing the record 51M sold in the year ago quarter by 46%. The astounding volume did not come at expense of price, as the ASP increased 7.8% YoY, driving iPhone revenues up by more than 57%. The price rise is a clear indicator of the success of the 5.5 inch 6 Plus model, which sold at a $100 premium to the 4.7 inch iPhone 6 and was the bellwether in the 70% YoY growth in sales to Greater China, now almost 20% of total revenues. As a result, Apple total sales of $74.6B were up 30% YoY and 14.7% higher than consensus, while its EPS of $3.06 were up 48% YoY and 17.7% above expectations. For all other companies watching – THAT is how you beat a quarter.

But what have you done for me lately? The bloggers and journos will yelp, but Apple stock is up less than 6% after hours on this awesome bludgeoning of consensus. Even though the beat down is likely far beyond the perma-bulls most fevered fantasies, and even though the March quarter is setting up as a bit of a mini-me repeat albeit with FX issues, it doesn’t seem to matter too much. Investors have turned from anticipating the huge response to the long awaited large screen iPhones to anticipating the company’s difficulty in growing against this new quarterly yardstick.

I’m sympathetic to that point of view. The iPhone is now 68.6% of Apple revenues, the highest percentage that it has ever been by a considerable measure. Considering the outsized margins of the iPhone relative to iPads or Macs, it is likely that the iPhone is responsible for 80% or more of Apple profit. If, as many suspect, the big numbers of big screen iPhones selling are driven, in significant part, by pent up demand from existing users, it may be that today’s sales are cannibalizing upgrades that may have otherwise have happened further down the road. When the iPhone 6 launched, there were ~50 million iPhone 4s, ~100 million 4Ss, ~100 million 5s, and ~150 million 5S/5C users in the wild. It is easy to believe that a number of these happy iPhone acolytes were induced to step up early. Tim Cook tried to wave off the question on the conference call, by first suggesting that Apple was seeing a lot of Android switching with the iPhone 6, then suggesting that only a “small percentage” of the installed base had upgraded in the quarter, and then, allowing that the “small percentage” was in the low to mid-teens. There were roughly 400M iPhone users at the start of the quarter. That means that 50-65M of the 74.6M units sold in the quarter were iPhone 6/6+ upgrades by existing customers, hardly a trivial percentage, particularly given that some of the units sold in the quarter were older models.

Assuming that Apple sells another 150-170M iPhone units during the last three quarters of its fiscal year, and that 70% of those sales are to existing customers, it may be that the percentage of Apple’s installed base with a new flagship model could be well higher than 40%, with more than 200M 6 and 6+ equipped users. Noting that the historical average upgrade cycle for iPhone buyers has been 2.3 years, it is likely that the remaining base will contain many users – many in unsubsidized markets and some with used models bought from the active secondary market – who are simply unable or unwilling to upgrade to the new flagship model. Having satiated the demand for big screen models, Apple is setting itself up for a tough compare come 1QF16.

Of course, emerging markets remain a strong source of demand for mature lines of iPhone and saw revenue growth of 58%, with Greater China (including Taiwan) growing 70% according to CFO Luca Maestri. Apple’s segmentation for FY 2015 no longer breaks out retail operations from geographic segments and the iPod segment has been retired now lumped into the “other products” category, which includes Apple TV, Beats, and will likely include the first iteration of the Apple Watch. The China compare is an easy one since the company only launched iPhone on China Mobile in January 2014, while sequentially the new handsets launched in China during the quarter. Still, operating the in world’s largest mobile market is compelling business proposition for Apple, especially in light of a thriving black market that saw iPhone 6s sent back to China at significant markups in the weeks after the handset initially launched the previous quarter.

Turning to the other 32% of the business, iPad continues to struggle, with unit sales off -22% YoY in the quarter. Apple has been seriously hit with fairly lackluster product undercut by excellent Android tablets in a market without subsidies, and now must contend with cannibalization from its own iPhone 6 phablet. The iPad’s revenue contribution has fallen from 20% to 12% of total and seems much more likely to go down than up. In contrast, the venerable Mac delivered its highest revenue producing quarter on a higher ASP, driven by the 5K iMac. Still, the Mac is barely 10% of revenue and not a significant growth driver. iTunes, iPad, Apple TV, and Beats round out the remaining 10% of revenue. This other category will see growth from Watch and Apple Pay, but not nearly enough to escape the gravity of iPhone. On the Watch, a tight lipped Tim Cook is sticking to an early 2015 timeline, which according to his definition of “early” would include the first four months of the year and likely has the device shipping come April.

Finally, guidance seems conservative into the next quarter with revenue of $52-$55B expected, or up about 20% YoY. On a sequential basis, revenue has typically fallen 20% in the quarter following the holidays over the last two years. The guidance would have revenue down as much as -30% sequentially. CFO Maestri noted the guidance includes expectations of FX headwinds to the tune of 5 points and no major events as 2FQ14 saw the launch of iPhone on China Mobile and the introduction of a tax in Japan spurred sales growth. FX headwinds have proven to be a vexing issue for Apple and the rest of the tech world where ex-US operations make up a substantial part of the business. Apple typically adjusts for currency fluctuations during a product launch, but recent events saw the company make unprecedented pricing adjustments mid-cycle in Russia with a collapsing Ruble. It could still do the same in Europe and other markets where currency weakness threatens margins.

Despite this, I fully expect Apple to deliver another significant beat in 2QF15. Still, it would seem Apple investors could be facing a game of chicken. On one hand, the next few months should see continued robust demand for the iPhone 6 and 6 Plus, as well as the inevitable hype around the launch of the Apple Watch. On the other hand is the specter that Apple may have played all of its card for its fiscal 2015, leaving little for 2016 but a stretch of impossible compares. I am willing to wait a bit for the euphoria to play out, but like many investors, I will be looking for a quick exit once it wears off.

For our full research notes, please visit our published research site.

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