Why Apple Inc. Stock Is Not A Sell Following Its Latest Earnings Report

  • Apple reported lower than expected earnings results for the second quarter.
  • iPhone, iPad, and Mac revenues declined YoY while services and other products increased.
  • However, I remain bullish on Apple for the long run.

The tech giant Apple (NSDQ:AAPL) reported its Q2 2016 earnings earlier last week and instantly became one of the biggest tech stories of the week. The company reported its first quarterly revenue decline since 2003 and re-ignited the debate about whether the company has exhausted its growth potential and whether Apple’s revenues are expected to stagnate and drop in the next few years. The company reported lower revenues and EPS than the market consensus and tried to sweeten the situation by announcing an additional buyback program and hiking its dividend by an impressive 10%. Even though the sales decline was expected and Apple has introduced a bigger capital return program, investors are concerned about 2016 growth as the company decreased its guidance for the next quarter. Apple’s stock price is down more than 10% (as of May 2 close) following the earnings release.

AAPL stock chart

Source: Apple stock price chart by amigobulls.com

The main issue in Apple’s results was the decline of the iPhone segment and the inability of the rest of the segments to offset that drop. The decline in iPhone revenues is a mix of a two factors: a 16% YoY drop in sales volume due to macroeconomic challenges worldwide, economic pressure in China, and smartphone industry headwinds, as well as a $50 QoQ drop in iPhone ASP affected by the iPhone SE sales. According to CFO Maestri, the impact of the iPhone SE will continue in Q3 – ASP, margins, and iPhone revenues are expected to drop again driving the guidance $5B lower than previously expected.

As mentioned in an earlier article, two of Apple’s smaller segments, the “services” and “other products” segments, attracted a lot of attention as they contain Apple’s emerging revenue streams Apple Pay and Apple Watch, and they serve as a proxy for Apple’s near-term growth as iPhone growth erodes. The 'other product' segment that includes Apple Watch sales increased 30% YoY to $2.2B, supported by 12-month watch sales that topped iPhone sales in its first 12 months of availability. The entire smartwatch market cooled down significantly since the incredible buzz and hype it had a year ago. The current watch sales volume is insignificant to Apple’s financials.

In the services segment, Apple presented a 20% YoY increase, supported by a 35% increase in App Store revenue, 5x transaction volume growth in Apple Pay, and Apple Music added 2 million new active users last month. Apple Pay's users base is growing at a rapid pace of 1 million new users per week worldwide, thanks to a successful launch in China and additional new locations that now accept Apple Pay payments globally. The Mac and iPad segments continued their double-digit slump with 12% and 19% YoY drop, respectively, fueled by ASP and volume decrease in both segments.

Looking at the broad picture of the entire Apple business, I can understand investors’ concerns about slowing growth and fears of an upcoming sell-off. However, investors should remain calm and not rush to close their Apple positions. Apple Pay and Apple Watch are in their early days and will gradually become more significant in the company’s revenue mix. Even though Apple currently projects a slowdown in iPhone sales in Q3, it is still early to estimate how the iPhone 7 sales will impact the company’s performance in the fourth quarter. Moreover, in the long run, Apple is expected to penetrate the electrical/autonomous vehicles market that should replace iPhone as the primary revenue stream for the company and potential M&A of a greater magnitude than Apple previously made could trigger many speculations about Apple's next focus area in the post-iPhone era. I remain bullish on Apple in the long run as I believe in Apple’s direction in the e-payments business, the electrical vehicle business, and believe that the company will grow further in the database and services businesses. For now, the expected drop in revenues driven by the iPhone sales decline does not fundamentally change my bullish thesis, and I remain long on Apple stock.

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