AAPL Q3 Earnings Preview: Is This the End of Lackluster Quarters?

This year, iPhone demand has taken a hit in critical regions like China, where market share has declined against local competitors. An example of how AI updates could ignite a new upgrade cycle can be seen in China. According to Wedbush analyst Dan Ives, out of 230 million iPhones there, 70% haven’t been upgraded in the last three years. Zooming out globally, out of the 1.5 billion iPhones in use worldwide, 270 million haven’t been upgraded in four years.
In my view, Apple’s durable hardware quality often delays the upgrade cycle. However, AI innovations in software and chips could likely accelerate the need for upgrades.
But this transformation will take time and will only materialize in the coming quarters. This makes Fiscally Q3 potentially a transitional quarter in this process, with customers possibly waiting for the iPhone 16 launch, thus holding back iPhone demand.

The main numbers to watch for Apple’s Fiscal Q3 are the consensus revenue estimate of $84 billion and EPS of $1.33. If Apple manages to beat EPS results again, it will mark the sixth consecutive quarter of beating estimates. In fact, with the exception of Fiscal Q1 2023, Apple hasn’t missed an EPS estimate since 2016.

However, even if Apple meets these numbers, they will represent modest annual top and bottom line increases of 2.7% and 5.6%, respectively. I believe this consensus is already loaded with skepticism about Apple delivering a modest June quarter in terms of performance.
Apple has been slipping with underperforming iPhone net sales for the past three quarters. In Fiscal Q2, year-over-year comparisons showed a roughly 10% drop in iPhone revenues as well as in the Wearables, Home and Accessories segment. iPad sales also fell dramatically by 17%. If it hadn’t been for the Services segment, which reached a record $23.8 billion in revenue for 14% growth, last quarter would have been even more tragic.
If there are any positive surprises expected in Apple’s Fiscal Q3 that could deviate from the current trend, they are likely linked to the performance of the Services segment. Investors should closely monitor this segment because it’s crucial for sustaining Apple’s growth, especially with the new iPhone “supercycle,” powered by AI, rolling out.
The seamless integration within Apple’s ecosystem has been key to the segment’s strong performance. This business often uses a subscription model, effectively capturing future revenues and adding predictability to Apple’s financials.
Thus, the Cupertino company managed to report gross margins of almost 75% in this segment, while products had a gross margin of 36% last quarter. The increased representation of Services also contributed to Apple maintaining strong operating income, reaching $27.9 billion, slightly higher than the LSEG consensus of $27.6 billion. This was not only due to increased revenue but also to a margin that exceeded expectations by 10 basis points.

AI Updates Are Likely Priced In
Many analysts have already accounted for Apple achieving 15% EPS growth and 8% revenue growth for Fiscal 2024. Some might find the forward P/E of nearly 31x quite high for a Big Tech company with single-digit projected top-line growth and trading well above its five-year average P/E of 28x (its current trailing P/E is 36x)
The stock’s notable underperformance earlier this year was quickly turned around following Apple’s forward-looking announcements about integrating AI into its devices. This propelled AAPL to all-time highs

Even though Apple’s AI updates are likely priced in ahead of Fiscal Q3 earnings, I believe that when AI demand starts hitting Apple’s immense user base, it will lead to continuous linear growth in net sales. That’s why my bullish stance on Apple remains strong for the long haul. I believe it’s a one-of-a-kind stock to own rather than trade.

Key Takeaway
Although Apple’s fiscal third quarter might show lackluster demand growth, it could signal the end of recent demand struggles, especially with AI advancements on the horizon. Challenges in product demand are likely to continue until the new iPhone launches and the AI-driven innovation cycle gains momentum in the coming quarters.
Therefore, Apple bulls shouldn’t worry too much if the Cupertino giant reports numbers that aren’t stellar. Fiscal Q3 might just be a period of holding steady until the bigger moves come into play.