Apple Earnings Review: iPhone Hits a Growth Wall, AI Innovations May Spark New Hope

After the U.S. stock market closed on Thursday, August 1st, Beijing time, Apple released its financial report for the third fiscal quarter of 2024 (which is the second quarter of the calendar year 2024). The report shows that the company's revenue increased by 4.9% year-on-year to $85.78 billion, and diluted earnings per share (EPS) increased by 11% year-on-year to $1.40, both exceeding market expectations. However, the continued decline in the core iPhone business and the greater-than-expected downturn in the Greater China region have raised market concerns.

As the company's primary source of revenue, the iPhone business is the focal point of the financial report. In FY24 Q3, the company's iPhone business revenue declined by 0.9% year-on-year to $39.3 billion. Although this was better than expected, it still failed to reverse the downward trend. The current growth bottleneck for the iPhone business is mainly due to the following reasons:

Innovation bottleneck: The iPhone is facing an innovation bottleneck, leading to insufficient consumer purchase motivation.

Deteriorating global consumption environment: The consumption environment in major countries around the world is worsening, and consumers' purchasing power is declining.

Decline in the Greater China region: The Greater China region, which represents the third-largest revenue share, has experienced a significant decline. In addition to the macroeconomic downturn, the rise of Huawei and other Android phones has also squeezed the iPhone's market share in the Greater China region.

Source: Company announcement

According to IDC data, China's smartphone market shipped approximately 71.58 million units in 24Q2, a year-on-year increase of 8.9%. However, iPhone shipments fell by 3.1% year-on-year, and have fallen out of the top five in China's market share. Although promotional activities have saved some sales, price cuts have also led to a decline in the average unit price of mobile phones. According to the company's financial report, the company's revenue in Greater China in FY24Q3 fell 6.5% year-on-year to US$14.73 billion, exceeding market expectations.

The AI-powered iPhone 16 series is expected to stimulate the upgrade cycle: the new generation of AI-powered iPhone is expected to be released in the fall of 2024, and North America will be the first market, while the upgrade cycle in the international market depends on the use of Apple AI in different languages. Time of regional rollout. Since Apple AI is only compatible with iPhone 15 Pro/Pro Max and iPads and MacBooks equipped with M series chips, it is expected to promote the replacement of existing models and trigger a new round of upgrade cycles.

Advantages of Apple AI: Apple AI has deep accumulation in software and hardware technology. Through active mergers and acquisitions in 2023, Apple has absorbed 32 AI companies and is about to launch AI-specific data center chips. The closed-loop iOS ecological model and AI technology help each other to build a comprehensive AI ecosystem, demonstrating significant competitive advantages.

The rise of emerging markets such as India: Revenue in other Asia-Pacific regions increased by 13% year-on-year to US$6.39 billion in this quarter, leading all markets. Among emerging markets, markets such as India are important growth points. As the middle class continues to grow, Apple is expected to occupy a place in the high-end market.

Source: Company announcement

This quarter, the service business revenue increased by 14% year-on-year to US$24.2 billion, a record high. The growth of the company's active device installation base has laid a solid foundation for the expansion of ecosystem services. In terms of the number of paid subscribers, the paid subscription volume of various services on the company's platform has exceeded 1 billion, achieving strong double-digit year-on-year growth. At the same time, both transaction accounts and paid accounts set a record high, and paid accounts increased by double digits year-on-year.

Apple has a huge installation base as a distribution channel. In the future, as cooperation with AI partners such as Open AI gradually strengthens, the monetization of Apple Intelligence is expected to drive the growth of the service business. It is expected that the service business will continue to maintain high double-digit growth in the next quarter.

This quarter, the iPad business recovered strongly, with revenue increasing by 24% year-on-year to US$7.2 billion, mainly benefiting from the launch of new products. Apple launched a new iPad Pro and two sizes’ new iPad Air at the new product launch conference on May 7. The price has also increased while the configuration has been upgraded.

Source: Company announcement

The Mac business performed relatively well, with revenue increasing 2% year-on-year to $7 billion this quarter, and demand was relatively weak. Apple released new 13-inch and 15-inch MacBook Airs equipped with M3 chips on March 4, 2024, but in terms of sales, Mac demand was relatively weak.

Source: Company announcement

In addition, the wearable and home business revenue fell 2.3% year-on-year to US$8.1 billion this quarter, marking the fourth consecutive quarter of decline. The sales volume of Vision Pro headphone products is low and its performance contribution is limited. It is expected that this business will find it difficult to reverse the downward trend in the short term.

The company's profitability remains basically stable. The company's gross profit margin was 46.3% this quarter, a slight decline from the previous quarter. Among them, the gross profit margin of hardware products was 35.3%, a decrease of 130 basis points from the previous quarter, mainly due to changes in the proportion of product sales, and the revenue share of the iPhone and Mac businesses declined; the gross profit margin of the service business was 74%, with a relatively small decline from the previous quarter. Benefiting from the good control of operating costs, the company's net profit increased by 7.9% year-on-year to US$21.45 billion this quarter, and the diluted EPS increased by 11% year-on-year to US$140 million.

Source: Company announcement

Supported by solid cash flow, the company's shareholder returns continue to improve. The company's free cash flow increased by 9.96% year-on-year to US$26.707 billion in this quarter, and cash and equivalents were US$25.565 billion. With the support of stable and strong cash flow, the company spent US$32.2 billion on repurchases and dividends this quarter. The intensity of shareholder returns increased significantly compared with the previous quarter (US$27.5 billion). Basically, all cash flow was used to give back. shareholder.

Source: Company announcement

Apple's current performance is still facing growth bottlenecks. In addition to the iPad business benefiting from the relatively strong recovery of product replacement, other hardware businesses such as the iPhone are facing growth pressure, mainly due to insufficient product innovation, macroeconomic downturn and insufficient consumer demand. Therefore, Apple's performance needs to wait for a new growth point to break through. It is expected that Apple's performance will usher in further improvement after AI-enabled products are released at the autumn conference this year.

Benefiting from good cost control and prudent external investment, the company's profit margin remains at a stable level. It is expected that the company's EPS growth rate in fiscal year 24 will be in the high single digit level, and the EPS growth rate in fiscal year 25 is expected to exceed double digits.

Shareholder returns are competitive. The company spent $32.2 billion on repurchases and dividends this quarter. It is expected that this scale can be maintained in the next three quarters. The company's annualized shareholder return rate is about 3.9%, which is basically the same as the current US risk-free interest rate (3.95%), and it is still competitive in the interest rate cut environment. The company's current valuation PE (TTM) is about 34x, and the 25-year PE (forward) is about 30x. The valuation is reasonable and high, and the attractiveness is relatively low.

Investors who hold the underlying stock can continue to hold it and consider selling a high-priced call option exercised before September.

Investors who do not hold the underlying stock can reduce the cost of holding positions by selling puts; or wait for a lower valuation before buying.