Market Has Low Expectations Ahead Of Apple’s Q3 Earnings

  • Apple will report its Q3 2016 earnings on Tuesday and will have a low consensus bar to cross.
  • The market expects a decline in most segments, an increase in services, and upped guidance due to Pokémon, chips, and services.
  • As we saw in Samsung’s case, the smartphone sales figures could surprise and drive short-term momentum.

The tech giant Apple (NSDQ:AAPL) will report its FY Q3 2016 earnings on Tuesday amid the latest 8% rise in stock price and significant recent development in the non-iPhone businesses. Apple’s beaten-down stock has been in a downtrend ever since the iPhone growth started to slow down (together with the entire high-end smartphones market), dropping 20% in the last year and 5% year-to-date. The decline in Apple’s stock is, of course, triggered by the iPhone sales slowdown that accounts for more than 60% of the company’s revenues. However, it is fueled by an additional YoY decline in the iPad segment and Mac segments coupled with disappointing Apple Watch volume ramp up.

Also Read: 3 Reason's Why Apple Inc's Stock Will Rise $100 A Share

In the interim period between the decline of the iPhone's business and the ramp up of Apple’s auto business, the company is ramping up new services like Apple Pay and Apple Music that will generate revenues, expand the iOS ecosystem, enable future capabilities in the auto business or next consumer electronics devices, and drive long-term growth. As the market expects disappointing results in most segments, all eyes will be on the services segment to see how Apple progresses in developing its emerging revenue streams.

The services segment performance is expected to be one of the focus areas of this earnings release amid the recent developments in Apple Pay, Apple Music, and the incredible hype around Nintendo (OTC:NTDOY) Pokémon Go. As I described in an earlier article, Apple made tremendous progress with Apple Pay—expanding the services to additional countries in Asia and Europe and launching Apple Pay for Safari to enable web transactions. Apple also made an enormous progress with Apple Music as it went directly at Spotify by adding a few hurdles on the Spotify’s app updates in the App Store and is in the process of acquiring Tidal and securing exclusive content to increase the company’s market share in the music streaming market on Spotify’s expense.

The surprising success of the Pokémon Go is another aspect of the services segment business that includes revenues from iTunes-related purchases. Even though the Pokémon Go game is free to download from Apple’s App Store, iPhone users can purchase in-app coins for $0.99 - $99 that unlock additional features in the game. Investment research firm Needham estimates that the percentage of paid users is ten times higher in Pokémon Go than in Candy Crush, which generated more than $1B of revenue in 2013 and 2014. According to Needham, Pokémon will contribute an incremental $3B to Apple’s top line in the next one to two years that was not projected nor captured in any outlook or guidance. The potential Pokémon revenues will not impact Q3 financials but should be an active catalyst for a revenues guidance increase, keeping all other factors equal.

Last week, chip giant Qualcomm (NSDQ:QCOM) reported its quarterly earnings and mentioned that some of the iPhone processors' volumes will shift from Qualcomm to Intel (NSDQ:INTC). The shift should drive a margin improvement in Apple’s iPhone segment and in the entire company's operating profit outlook. It should be an interesting topic to monitor and see whether Apple considers this a significant factor that impacts its guidance.

Overall, the market consensus reflects disappointing quarterly results by Apple with a 15% drop in top line YoY and a 28% drop in bottom line YoY. These lowered expectations amid the decline in iPhone sales, coupled with the decline in iPad and Mac sales and low revenues from services, set a pretty low bar for Apple to cross. It has been a widespread phenomenon this earnings season to see a low market consensus that was easily beaten but did not trigger a rally in the stock price.

While investors expect the worst case scenario and focus more on the guidance than the actual financials, Apple could surprise the street and create some short-term momentum just as happened with Samsung Electronics (OTC:SSNLF) at the beginning of the month. The Korean tech giant reported strong financials with a healthy demand for Galaxy S7 that pushed the mobile operating margin up to the highest level since 2014. A surprise increase in iPhone sales, a significant improvement in Apple Pay/Apple Music and an updated higher guidance should drive a rally in stock price. However, it is more likely that the results of this earnings release on the stock will be minor following the huge changes taking place in the company.

These are the comparable figures to watch:

Q3 2016 Consensus Q3 2015 Actual
EPS $1.38 $1.86
Revenues $42.11B $49.605B
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