Apple Earnings Preview: Can AI Products Offset Slumping iPhone Revenue?

After the Q2 financial report was released on May 2nd, the company's stock price continued to rise, especially after the official launch of Apple Intelligence (hereinafter referred to as "Apple AI") at WWDC on June 10th, the stock price significantly rose and reached a historical high of $237.23. However, under the influence of the weak performance of the stock price after the recent technology stock financial report, as of July 25th, Apple's stock price has fallen to $218.54.

Diluted earnings per share will reach $1.34, a year-on-year increase of 6.54%.

Revenue is expected to grow to $84.359 billion, up 3.13% year-over-year.

The expected profit margin will reach 30.15%, a decrease of nearly 2 percentage points month-on-month and an increase of 7 percentage points year-on-year.

Apple's revenue growth has been declining for more than a year, with a contraction of 4.31% in the last quarter, including a nearly 10% decline in hardware sales. However, with the launch of Apple AI, the market optimistically predicts that revenue in the next quarter can reach $84.359 billion, a year-on-year increase of 3.13%.

Apple's core business includes hardware products, led by iPhone, and an expanding services business. The hardware product line covers not only iPhone, Mac, and iPad, but also wearable devices such as Apple Watch. As the company's flagship product, iPhone has always been an important pillar of Apple's revenue, accounting for about half of total revenue.

Apple's main competitors in the smartphone market are Samsung and Huawei. Samsung is known for its excellent hardware configuration, screen quality, and advanced camera technology, while Huawei is praised for its powerful performance and excellent photography capabilities. In addition, Samsung has established a certain differentiation advantage in the high-end market by launching a foldable phone series.

Apple's competitive advantage lies in:

(1)Absolute leading position in the high-end market. Last year, Apple's share in the global high-end smartphone market reached 71%, while Samsung ranked second with 17%, and Huawei only had a 5% market share.

(2) Closed-loop iOS ecosystem. Users purchase not only hardware products, but also iOS operating systems and their application stores and other services, providing customers with a complete and coherent user experience, becoming one of the core competitiveness of iPhone.

(3)Brand Loyalty and User Experience.

Driven by the global technology wave, the smartphone market has ushered in a new round of growth peak. According to preliminary data from IDC report, the global smartphone market shipments in Q2 this year increased by 6.5% year-on-year to 285.40 million units. Thanks to the strategic focus on flagship products and strong AI strategy, iPhone ranked second with a 15.8% share, a year-on-year increase of 1.5%, and improved performance in China and other key regions. It is expected that iPhone shipment volume in Q3 will decline to 43.37 million units.

Similar to the global market situation, the continuous recovery of market demand has helped the Chinese smartphone market continue its rebound momentum at the end of last year, and the market performance has exceeded expectations. According to IDC data report, in Q2 2024, the shipment volume of China's smartphone market was about 71.58 million units, a year-on-year increase of 8.9%. Compared with Quarter 1's 69.26 million units, it increased by 3.3% month-on-month. However, this growth is mainly driven by the Android market, which increased by 11.1% year-on-year.

Previously, Apple's revenue in Greater China fell by more than 8% year-on-year in the first quarter of this year. In terms of the market, Apple's share of the high-end market above $600 in China fell from 58% last year to 45.5% in the first quarter of this year, and the combined share of Huawei and other domestic brands has exceeded 50%. Faced with the declining share, Apple responded to competition by slashing prices. According to IDC data, Apple's lowering of its stance and price cuts have indeed reduced certain negative impacts. Although Apple's market demand has improved after a significant price cut, the shipment volume of iPhone still decreased by 3.1% year-on-year and has fallen out of the top five positions in China's market share.

The latest data released by the China Academy of Information and Communications Technology (CAICT) shows that sales of iPhone in May increased by 44% month-on-month and 40% year-on-year. Although this growth is positive, it is still lower than Apple's previous level.

According to Bloomberg consensus expectations, Greater China revenue is expected to decrease to $15.203 billion next quarter, down 3.52% year-on-year.

Compared to the previous quarter, the growth of the US economy has significantly slowed down. Retail sales in April 2024 decreased by 0.7% compared to the previous quarter. In May, the growth rate of retail sales was + 0.1%, lower than the expected + 0.3%, while the retail data in June remained unchanged from May. This lower-than-expected data indicates that US consumption is under pressure in a high interest rate environment and is weakening overall. The market expects FY24Q3 North American revenue to be $36.427 billion, a year-on-year increase of 2.95%.

Currently, an important growth point for Apple is Emerging Markets such as India. In Quarter 1, the shipment volume of iPhone in India reached a historic high, with a year-on-year increase of 19%, occupying a 6.8% share of the Indian smartphone market, ranking sixth. In the 12 months ending in March, Apple's revenue in India reached $8 billion, a year-on-year increase of about 33%.

The market expects revenue in Japan and other Asia-Pacific regions to increase by 6.88% and 7.14% respectively year-on-year in the third quarter. Although Emerging Markets expects rapid sales growth, its revenue expectation of less than $12 billion is still insufficient to provide significant support compared to the expected $38.901 billion revenue of iPhone FY24Q3.

After experiencing eight consecutive quarters of decline, the traditional PC market ushered in the second quarter of continuous growth. According to IDC's survey results, the global PC shipments in Q2 2024 reached 64.90 million units, a year-on-year increase of 3.0%. Although the overall market benefited from the good performance compared to 2023, the weak performance of the Chinese market brought a negative impact of more than 2 percentage points to the market, continuing to hinder the development of the market.

Among them, the shipment volume of MacQ2 5.70 million units , accounting for 8.8% of the global market share, ranking fourth, higher than market expectations. Compared with the shipment volume of the same period last year, it increased by 20.8% year-on-year.

Apple released a new MacBook Air with the M3 chip on March 4, 2024. The new 13-inch and 15-inch M3 MacBook Airs are priced at $1,099 and $1,299 respectively. These two new models will begin accepting pre-orders at 9:00 am on March 6 and will be officially released on March 8.Compared to the starting price of $1199 for the M2 13-inch MacBook Air, the cost-effectiveness of the M3 13-inch MacBook Air has improved.

Due to the economic downturn and the lack of new models, iPad sales experienced a downturn last year and focused on clearing inventory of old models in Quarter 1 of 2024. Quarter 1 iPad revenue decreased by 16.66% year-on-year.

Apple launched a new iPad Pro and two sizes of new iPad Air at its new product launch event on May 7th. In addition to the upgraded configuration, the price of the iPad Pro has also increased. The 11-inch model starts at $999, higher than the previous starting price of $799. The 12.9-inch model starts at $1299, higher than the previous starting price of $1099, making it Apple's most expensive tablet. In terms of the iPad Air series, the 10.9-inch model starts at $599, and the 12.9-inch model starts at $799. This is the first new iPad model released by Apple since October 2022 and the longest update since the product line was launched in 2011.

According to Bloomberg consensus expectations, iPad revenue is expected to increase to $6.63 billion in the third quarter, a year-on-year increase of 14.48% and a quarter-on-quarter increase of 19.26%.However, it is expected that the full-year revenue in 2024 will decrease to $26.05 billion, a year-on-year decrease of 7.95%.

Although Apple's wearable business still firmly occupies the first place in global market value, the revenue data of the wearable business in the past decade shows that its growth rate has slowed down significantly.The market expects the wearable business revenue to fall to $7.82 billion in FY24Q3, a year-on-year decrease of 5.6%.

It is worth noting that Apple's headset product Vision Pro officially entered the international market on June 28th, after being launched in the US on February 2nd. It is expected to bring Apple $414 million in revenue in FY24Q3Vision Pro. Although from a long-term strategic layout perspective, this product is expected to drive the company's revenue growth, its contribution to performance in the short term is relatively limited, especially in supporting Apple's revenue in FY24Q3.

The strong strength of iPhone's surrounding ecosystem is reflected in its rapidly growing service business, which includes services such as App Store, iCloud, and Apple Music. These services not only bring stable revenue streams to Apple, but also show higher customer stickiness and repeat consumption potential compared to hardware sales. More importantly, the gross profit margin of the service business is significantly higher than that of hardware products - the gross profit margin of the service business reached 74.6% in the previous quarter, while the gross profit margin of hardware products was only 36.6%. It is expected that the gross profit margin of the service business will remain at a high level of 72.21% in FY24Q3.

According to Barclays' report, in FY24Q3, App Store revenue increased by 13% year-on-year. Specifically, in June, App Store revenue increased by 13% year-on-year, a decrease of 200 basis points from May, and decreased by 3% month-on-month, which is consistent with seasonal trends.

From the above chart, it can be seen that the growth rate of service business revenue has slowed down slightly since 2024. Bloomberg's consensus expectation shows that Apple is expected to reach $23.934 billion in FY24Q3 of service business revenue, an increase of 12.83% year-on-year. The gross margin is expected to remain stable at 72.21% compared to the previous two quarters, an increase of 2.5 percentage points year-on-year. Barclays predicts that as the comparison base gradually increases in the future, the growth rate of the App Store may slow down to a medium to high-digit level.

The iPhone of the new generation of AI empower will be released in the fall of 2024. In the sales of this new series, the North American market is seen as the main driving force, while the upgrade cycle of the international market is subject to the timing of the launch of Apple AI in different language regions, which is expected to begin to affect sales after the release of iPhone 16. At the same time, since Apple AI is only compatible with the iPhone 15 Pro/Pro Max and iPads and MacBooks equipped with M-series chips, the base of users iPhone 15 Pro and 15 Pro Max will prompt them to upgrade in the second year, when iPhone 17 is released.Based on the above reasons, the market predicts that AI-driven sales will show a two-year stepwise growth, with sales expected to increase by 22 million units in the first year and 24 million units in the second year.

1）Advanced technology builds a solid foundation: Through active mergers and acquisitions in 2023, Apple has absorbed 32 AI companies and will soon launch AI-specific Data Center chips, demonstrating Apple's leadership in hardware.

2) Closed-loop iOS ecosystem and AI technology help each other: iOS closed-loop ecosystem combines "self-developed chip + iOS operating system + App Store" to achieve a high degree of integration and unified management of software and hardware. Compared with other AI-integrated smartphones, this model makes it possible to seamlessly experience AI functions in iOS, iPadOS and macOS operating systems, build a comprehensive AI ecosystem, and show significant and unique competitive advantages.

According to Bloomberg consensus expectations, the FY24Q3 iPhone 15 series products will contribute 28.88 million shipments, and the next quarter, the iPhone 16 series with AI is expected to bring 27.10 million shipments, and the overall revenue is expected to increase to $92.90 billion.

According to Bloomberg's consensus expectation, Apple's operating costs in FY24Q3 are expected to reach $14.381 billion, a year-on-year increase of 7.2%. Gross profit is expected to be $38.965 billion, although it has decreased compared to before, the gross profit margin remains stable at 46.03%, an increase of 3 percentage points and a month-on-month increase of 1.55%.

Net Profit is expected to reach $20.634 billion for the quarter, up nearly 4 percentage points year-over-year and down nearly 13 percentage points quarter-over-quarter. Earnings per share (EPS) is expected to grow to $1.35, up 6.69% year-over-year, with speculation that FY24Q3 has increased share buybacks .

Apple will continue to maintain a stable operating profit margin and net profit margin, the latter of which has been maintained at about 25% for the past few years.

The launch of Apple AI is expected to increase the average selling price of hardware devices and also increase its profit margin. The market expects the net profit margin to further increase to 24.55% in the next quarter, a year-on-year increase of 1.01%; the operating profit margin is expected to reach 30.15%, an increase of over 7 percentage points, and a decrease of nearly 2 percentage points compared to the previous quarter.

Despite the rapid development of artificial intelligence technology, Apple has not yet announced plans to significantly increase capital expenditures to support its ambitions in the AI field, which means that capital expenditures will remain within the normal range of $10 billion to $11 billion per year. The expected sales and management fee ratio is 7.62%, a year-on-year increase of 4.39%; the R & D expense ratio is 9.39%, a year-on-year increase of 3.18%.

Apple is facing a complex market environment recently, especially with a decline in market share in China and weaker consumption in the North American market. Revenue in Greater China is expected to continue to decline, while revenue in the North American market is expected to continue to grow despite slowing economic growth. In terms of product lines, iPhone revenue is expected to decline slightly, while Mac and iPad are expected to grow, and wearable product line revenue is expected to decline. Service business revenue is expected to maintain double-digit growth. Although Vision Pro headset products and the upcoming AI empower iPhone 16 series are expected to drive revenue growth in the future, their contribution to performance is limited in the short term. Overall, although there are some growth opportunities, such as the expansion of the Indian market, the launch of Vision Pro, and the application of AI technology, these opportunities are currently not enough to offset the impact of weak demand in the Asian market, nor can they provide enough impetus for Apple to achieve double-digit sales growth.

According to Bloomberg's consensus forecast, Apple's total revenue is expected to increase to $84.359 billion, a year-on-year increase of 3.13%; earnings per share (EPS) are expected to increase to $1.35, a year-on-year increase of 6.69%. Despite facing many challenges, the strong performance of its services business and the launch of new product lines provided support for its weak growth in FY24Q3.

On Thursday, May 2nd, after the US stock market closed, Apple announced the largest stock buyback plan in US history at $110 billion , while increasing the dividend by 4% to 25 cents per share. Although it is considerable in absolute terms, with Apple's current market value of $3.34 trillion, it only accounts for about 3.29% of the current market value. The current dividend yield is about 0.44%. Considering that the US risk-free interest rate is declining, the shareholder return of 3.7% can provide some support for the stock price.

According to Bloomberg forecast data, the expected Apple Price-To-Earnings Ratio in 2024 will reach 32.85 x , and the expected earnings per share in 25 years will increase by 12.86% year-on-year, and the Price-To-Earnings Ratio will drop to 29.68 x .

Overall, Apple is a solid company with strong cash flow generation capabilities, which allows management to announce large-scale stock buyback plans while maintaining growth plans and maintaining a strong financial position.

However, the problem is that the current Price-To-Earnings Ratio multiple is too high, and although growth tends to stagnate and future growth potential is uncertain, this multiple seems to continue to rise. Given that the current Price-To-Earnings Ratio is about 33x, we usually expect sustained double-digit growth, but the actual situation is obviously not so.

For investors who hold the underlying stock, Apple stock is still worth holding. Considering that there is relatively little room for the stock price to rise after the financial report, they can sell a high-priced call for arbitrage protection.

For investors who do not hold the underlying stock, they can wait for lower buying costs.

In addition, Apple has many leveraged ETFs that can amplify the volatility of the underlying stock: