Apple Inc. Growth Slows, Still A Cash Cow

Jul.24.13 | About: Apple Inc. (AAPL)

On Tuesday evening, Apple (NASDAQ:AAPL) made some of its investors pretty happy with its quarterly earnings announcement. The company beat the analyst estimates even though the results were worse than the same period last year.

The company generated $35.3 billion, which translated into $6.9 billion of net profits ($7.47 per share). Compared with the same quarter a year ago, the revenue was flat but net profit was down as the company was able to generate $35.0 billion and earn $8.8 billion ($9.32 per share) in the same quarter last year. The analysts were looking for Apple to generate $35.0 billion in revenues and $7.32 per share in net income.

Apple's margins fell due to a cheaper mix of products sold in the quarter. In the third quarter of 2013, the company's gross margin was 36.90%, which is down from 42.80% obtained in the same quarter a year ago. The investors were already expecting the gross margin to fall, so there was no surprise there. In the next quarter, the company expects margins that are similar to the margins in the last quarter.

The average sale price of iPhones continued to fall as it hit $582 in the last quarter, down from $613 in the previous quarter. There were a large number of iPhone 4 and iPhone 4S models sold, which affected the average sale price and margins negatively, but this should also teach the company that consumers are looking for iPhones with cheaper prices. Also, because of the iPhone 4 and iPhone 4S sales, Apple was able to beat analyst estimates in volume. Apple sold 31.2 million iPhones in the quarter; whereas, the analysts were looking for a number well below 30 million.

After spending $14 billion on buybacks (which reduced the share count by 22 million), the company increased its cash position to $146.6 billion and the company's balance sheet includes debt of $17 billion for the first time in years. This was already announced and already expected by the investors though.

While iPhone volumes continue to perform greatly in the U.S. with a growth rate of 51% compared to June of 2012, there was slowdown or decline in many parts of the world. Japan was another strong market for the company with double-digit growth; however, things weren't so good in Europe where iPhone volumes saw declines of 8% in Europe, 14% in China (much of the weakness in China was attributed to Hong Kong during the earnings call), and 18% in the rest of Asia excluding Japan. During the quarter, the market share for iPhone in the commercial markets (businesses, education institutions and government organizations) rose to 62.5%.

It looks like Apple's growth came to a screeching halt. The company is facing a market that is rapidly getting commoditized. The growth might not come back to the company until it comes up with a new "revolutionary" product.

Just because the rate of growth slowed down doesn't mean Apple is overvalued though. In recent months, there was so much fear and worry built in the company's stock that it was priced for the worst-case scenario. Apple is still the most profitable smartphone company in the world and this is not likely to change anytime soon. In the last quarter, every major company in this industry including but not limited to Nokia (NYSE:NOK), Samsung, Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG) and BlackBerry (NASDAQ:BBRY) mentioned the increasingly competitive market and how things are getting tougher and tougher for the companies. As a result, most smartphone companies in the world have either negative or razor thin margins whereas Apple continues to dominate the profit-share in the world. Now that the worst-case scenario for Apple didn't happen, the investors can take a long deep breath of relief.

In the high-end smartphone market, much of the easy money has already been made and there aren't many people who can afford a high-end smartphone but don't already have one. Most people who want a high-end smartphone but who are without it are not likely to be able to afford one unless the prices come down, and most people with a high-end smartphone already have one (by definition). Luckily, Apple has high customer retention rates and it can at least maintain its revenues. Later on, when cheaper iPhone models come out (as we've seen with iPhone 4 and iPhone 4S since the introduction of iPhone 5) the company will continue to see revenue growth even though its margins might get narrower.

The average Apple store revenue fell from $11.1 million to $10.1 million. Despite the fall, the number is still very strong. When we look at revenue per square foot, Apple is performing similar to high-end jewelry stores, which is impressive. This quarter, the company will add nine new stores to bring its total number of stores to 417.

During the call, Oppenheimer didn't provide much detail about what the company is planning to do for the next couple quarters other than saying that Fall will be very busy for the company. It will be interesting to see if Apple can add new product types to its list. Investors probably wouldn't be too happy about having another holiday season with Apple products that are only incrementally better than the previous ones. When asked about the saturation of high-end smartphone market, Tim Cook said that he didn't see it happening and that the company would seek growth through offering new products and services. Many people are expecting something like an iWatch or iTV in the near future but the company has been pretty tight lipped about it.

On a related note, Apple also reported slowness in growth of its other products such as iPads and iMacs. As more companies join the tablet race, Apple might be losing its edge in these products even though it continues to produce the highest quality products with highest user friendliness. Some people might not be willing to or able to pay a premium price for the company's products, which may fuel growth for the competition that offers cheaper products. Again the question comes down to whether the market is saturated and the number of people who can afford these products but haven't already bought them becomes another item of question.

It's interesting how Tim Cook didn't give direct answers to any of the questions during the question and answer session. For example, when he was asked whether a cheaper iPhone is coming to the market, he simply said that there is a strong demand for Apple's iPhone 4, which saw a price decrease once iPhone 5 hit the markets. Tim Cook didn't give further details and many investors will be wondering whether Tim Cook meant "since we see strong demand in iPhone 4, having a cheaper iPhone seems like a good idea" or "since we already have a cheaper iPhone in market, we don't really need another one." For another example, Mr. Cook also said "we are working on some stuff that we are really proud of, and we will see how it does and announce things when we are ready," which doesn't really tell us anything. Apple's management has always been tight-lipped about future plans and that's just the way things are. I don't expect this to change anytime soon.

Apple's iTunes continued to perform strongly in the last quarter. The total billings reached $4.3 billion generating $2.4 billion in revenues, which is up 29% from last year and an all-time high. Combined with other software and services, iTunes generated more than $4 billion in revenue in the last quarter, which is more than many phone companies generate in hardware and software combined together.

In conclusion, while Apple's growth has slowed down considerably since last year, the company is still doing much better than the competition. Apple is still a cash cow and the company still accounts for most of the profits in the smartphone market by itself. In the future, the company's growth will depend on the new products and launching a number of cheaper products will help the company's revenues greatly even though they may hurt its margins. I expect Apple's share price to appreciate nicely in the next few months because all the fear and worries will start subduing.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.