Apple (NASDAQ: AAPL) delivered its third-quarter earnings report after the market closed on July 30. The results exceeded market expectations on both the top and bottom lines. The company reported earnings per share (EPS) of $2.18 on revenue of $53.82 billion (analysts had forecast $53.39 billion). The numbers supported the “whisper number” of $2.18 that some analysts had been floating in recent days. Not surprisingly, the stock was surging over 4 percent immediately after the announcement.
One of the reasons the company cited for the positive report was an improving situation for iPhone sales in China. Historically, iPhone sales and Apple’s stock have had a nearly perfect correlation. So it stands to reason that when Apple announced a 17 percent decline in sales in their second-quarter earnings report, the stock took a dip.
But the thing about trends is that they exist until they don’t. Even before the announcement, Apple’s dip had largely been reversed. In fact, Apple’s stock is up over 20% since its decline in June, and the tech giant is up over 30% for the year, easily outpacing the S&P 500 Index. So if iPhone sales are still sluggish, what’s going on?
Apple’s brand is growing beyond the iPhone
Apple has been under intense scrutiny particularly because its signature iPhone is seeing softening sales in China. However, Apple is starting to show signs of weaning itself away from complete dependence on the iPhone. In Q2 of 2018, the company cited an increase in revenue from their wearables, home, and accessories segment (Apple Watch, AirPods, Beats, etc.) was up 30% year-over-year. Brad Moon, a leading financial blogger says, “Apple is/was too reliant on a single product. Over the past few years, however, Apple has put more of its focus into improving its current products, widening its services and developing new technologies.” Moon went on to conclude that, going forward the whole of Apple may be greater than the sum of any one part, including the iPhone.
Is the worst over for Apple?
But investors are rightly asking is the worst over for Apple? Some analysts believe that even with a more diverse product line, Apple will still not be able to add enough to their earnings to make up for what they are losing as customers wait for the 5G iPhones.
To answer that question, you have to understand what the company has been up to and why the correlation between iPhone sales and their stock price may be setting the table for Apple to soar above analysts’ expectations.
Apple is making a $1 billion bet on 5G
Apple led what has been termed the “i” revolution like the iPhone, iPad, and iPod put the internet in consumer’s hands and pockets and revolutionized smartphones, computers, music and so much more.
Just as Apple led the charge then, they are poised to lead the charge for what is expected to be one of the greatest wealth creators in American history.
However, taking this giant step forward meant taking a couple of steps back.
Apple was in a prolonged legal battle with Qualcomm, Inc. over access to their modem chips that Apple needed in order to produce Apple’s 5G phones. Apple and Qualcomm came to an agreement in early 2018, but as it turns out, Apple was just getting started. In late July, the company announced that it was spending $1 billion to acquire the majority of Intel Corporation’s smartphone modem business. It was Apple’s largest merger in a decade. While it’s true this investment will ensure that Apple is not dependent on Qualcomm to deliver modem chips for their 5G phones, Apple has a long-term strategy that requires having control of this critical piece of new technology.
It will take some time for 5G to overtake 4G. Part of this will be because of availability and part of this will be cost. This acquisition puts Apple in the driver’s seat because of the new technology and the modems that power it will be linked to a brand that consumers already know and love.
Although analysts will want to see Apple show a smaller decline in sales than the 17 percent they reported in their Q2 earnings, Apple is expecting to see softer demand for their iPhones for the remainder of 2019. Due to their premium cost, iPhone owners tend to wait for significant feature enhancements before purchasing a new phone. This means current iPhone users may hold off until 2020 when Apple is forecast to release at least two 5G models.
Apple is building an ecosystem and a moat
The 5G revolution is coming and Apple is taking steps to ensure they are on the leading edge. But they aren’t stopping with the iPhone. Apple is seeing incredible growth in its Services business which includes Apple Music and has higher gross margins than its Products business. Apple has also announced the launch of its own streaming service, Apple TV Plus, which will put it in close competition with fellow FAANG stock Netflix.
All of this means that far from surrendering its leadership in the smartphone arena, Apple has been quietly laying the groundwork for a major move that will help transform the company’s ecosystem that will deliver streaming digital offerings for customers to watch over 5G technology on their iPhone or iPad.
Apple has a history of defying rumors of its demise. If the second-quarter earnings represented a bottoming out, the next leg up may exceed all analysts’ expectations.