Apple Earnings Preview: iPhone Sales Waterloo, Stock Price Clouded by Gloom

Apple's main business is divided into two major parts: hardware products and software services, where:

(1) Revenue from hardware products primarily comes from the sales of iPhones, iPads, Macs, and other wearable devices and accessories (such as AirPods, Apple Watch), with iPhone sales accounting for over 70% of the hardware products' total revenue and over 58% of the company's total revenue;

(2) Revenue from software services mainly comes from the App Store, payments, iCloud, and other related business sales.

Chart: Apple's Main Business Revenue Structure

In terms of profits, Apple's profits mainly come from hardware product sales and software service businesses:

(1) Hardware product sales are the main source of Apple's profits, with iPhone sales being the largest contributor. While Mac and wearable device revenues do not match those of the iPhone, these product lines together make a significant contribution to Apple's profits.

(2) The services business has become one of Apple's fastest-growing sectors, bringing stable high-margin revenue to the company. Although service revenues represent a smaller proportion compared to hardware, they play a key role in enhancing Apple's overall profit margins and building ecosystem stickiness.

Chart: Apple Profit Composition (in billions of USD)

The latest report from the International Data Corporation (IDC) reveals that in the first quarter of 2024, Apple's iPhone series suffered a major blow in global shipments due to strong competition from Chinese rivals Xiaomi and Transsion Holdings. Total shipments were only 50.1 million units, a sharp decline of nearly 10% year-over-year, with its market share dropping from 20.7% a year ago to 17.3%, falling from first to second place globally.

Chart: Global Smartphone Market Share (%)

Furthermore, in the Chinese smartphone market, Huawei regained the top spot in market share with a strong performance of the Mate and nova series in the first quarter, reaching a total shipment of 11.7 million units and capturing part of the iPhone's market share in China. According to Canalys data, iPhone's total sales in China for the first quarter of 2024 were 10 million units, down 19% year-over-year, marking the company's worst performance since 2020. Additionally, with other smartphone manufacturers like Xiaomi and Samsung expanding their overseas markets, Apple's product sales in Europe, Japan, and other markets are also expected to face significant declines. Given that sales revenue from hardware products like the iPhone is the mainstay of Apple's revenue, we anticipate that the sharp decline in iPhone sales during the first quarter will lead to a decrease in revenue for the hardware products division.

Apart from the iPhone, Apple's Mac and wearable products are also facing significant sales pressure, as evidenced by the following:

(1) In March of this year, Apple released its new Mac product line. The lack of significant innovation in the new products did not greatly attract users. Meanwhile, competitors such as Lenovo and HP have seen an increase in global computer sales in the first quarter, squeezing the market share of Apple's Mac series products globally. Based on first-quarter sales, Mac's overall shipments were only 4.4 million units, more than 400,000 units lower than the same period last year. According to Bloomberg consensus estimates, Mac's sales revenue for the first quarter is expected to be 6.8 billion yuan, a year-over-year decline of 5.3% and a sequential decline of 13%.

Chart: Global Computer Sales

(2) In terms of wearable products, reports indicate that many customers requiring these products may wait for the new Apple Watch and AirPods 4, expected to be released around September this year, to benefit from updated product performance. Therefore, the company's wearable product sales are also facing the risk of a decline in the first quarter. According to Bloomberg consensus estimates, the revenue from wearable devices in Q1 2024 is expected to be $8.29 billion, a year-over-year decline of 5.36%, and a sequential decline of 30%.

Apple's software services generate revenue through various methods, such as Apple Music subscription fees, Apple TV+ paid services, iCloud paid storage, Apple Pay transactions, AppleCare warranties, and search engine advertising investments. As of the end of the 2023 fiscal year, Apple's software service products have amassed over a billion paying users, driving rapid revenue growth for the software services business.For the first quarter of 2024, we expect the following growth opportunities in software service revenue:

(1) Since 2023, Apple's Apple TV+ has been continuously releasing premium paid programs such as "The Family Plan," "The Morning Show," and "For All Mankind," which drove a 42% year-over-year increase in viewership in 2023, attracting more paying users. This trend is expected to continue in the first quarter.

(2) Due to Apple's relatively closed iOS system, iPhone users can only download applications from the App Store, and all in-app purchases must go through Apple, resulting in fees that Apple takes a cut of 15%-30%, commonly known as the "Apple Tax." Considering that the number of paying users is likely to continue the upward trend from the previous quarter, we expect the income generated from the Apple Tax to increase.

It is important to note that Apple's system has become a target for antitrust actions in various countries. The EU market has already started implementing the Digital Markets Act at the beginning of this year, requiring Apple to adjust the fees it charges users and developers. Similar legislation is also being advanced in the United States, Japan, and other regions. These measures will undoubtedly put pressure on the growth rate of Apple's service income, so we anticipate that Apple's software service revenue growth will face significant pressure in the short term.

Chart: Apple Software Service Revenue Change (million USD, historical data)

According to Bloomberg consensus estimates, Apple's software service revenue for the first quarter of 2024 is projected to be $23.28 billion, up 11% year-over-year and maintaining a stable growth rate sequentially. The growth in software service revenue has somewhat mitigated the loss of income caused by declining hardware product sales, but since this segment accounts for less than 20% of total revenue, it cannot fully offset the negative impact of declining sales. According to Bloomberg consensus estimates, Apple's total revenue for the first quarter of 2024 is expected to be $90.3 billion, a year-over-year decline of 4.8%, and a sequential decline of 24.5%.

We expect Apple's gross margin to continue to be under pressure in the short term, with no clear positive factors at present. Overall, the positive and negative factors affecting Apple's gross margin for the first quarter of 2024 compared to the previous quarter, are as follows:

(1) Significant decline in iPhone sales – Negative, substantial impact.

The decline in iPhone sales has led to a significant reduction in hardware product revenue, negatively affecting total revenue and further impacting gross margin.

(2) Increase in software service revenue – Positive, minor impact.

The rise in software service revenue has a positive effect on total revenue and further contributes to an increase in gross margin.

(3) Rising component costs – Negative, minor impact.

According to data from surveys of Apple's suppliers, the production costs for the iPhone 15 series have increased relative to the previous generation models. For example, titanium alloy frame costs have reached $50, which is 43% higher than traditional stainless steel; and the cost per A17 Pro chip is $130, a 27% increase from the A16 chip.

Chart: Apple Gross Margin (% historical data)

2. High Market Valuation

From a valuation perspective, after several weak quarters, AAPL stock performed strongly in fiscal year 23, leading to a high valuation. Currently, Apple's valuation stands at a P/E ratio of 25 times, placing it in a leading position among industry peers. However, for the first quarter of 2024, we believe the significant drop in hardware product sales revenue poses a risk of devaluation for the company.

In 2023, Apple's total buyback amount was $83.9 billion, and with Apple's current market capitalization exceeding $2.6 trillion, this represents less than 1%; additionally, the company's dividend yield is only 0.56%, which is also at a relatively low level, resulting in a combined shareholder return of less than 2%.

Considering that the risk-free rate in the United States is approaching 5%, and Apple has not announced any significant buyback plans for 2024, related institutions predict that Apple's buyback amount for 2024 will be around $90 billion, not much different from 2023. Therefore, we expect that Apple's shareholder return will remain low in the first quarter and will continue to be below the U.S. risk-free rate level.

Since the start of 2024, Apple's stock performance has been notably weaker than the S&P 500 index. From the perspective of stock price fluctuations, since the new year, Apple's stock price has only fallen by 8.7%; we believe the anticipated decline in first-quarter performance has not been fully reflected in the stock price. Considering the weak market demand for Apple products in the first quarter, we expect both total revenue and net profit to decline, and further speculate that there is a significant likelihood of a drop in Apple's stock price following the earnings release.

(1) Purchase put options for the company. If the stock price falls as expected, the value of the put options will rise, and investors can profit by selling the options or exercising them.

(2) There are also Exchange-Traded Funds (ETFs) available on the market for shorting Apple's stock: