Apple: Brace For Impact

| About: Apple Inc. (AAPL)

Summary

AAPL will report on Tuesday with consensus expecting $3.23 in EPS and $76.6b in revenue.

iPhone shipments are expected to be 75m-80m with consensus expectations already lowered from 80-85m from three months ago. Anything below 75m would further weigh in on the stock price.

App store sales continue to gain momentum and is perhaps the most attractive segment in AAPL. Unbundling of AAPL services may be key to protect the AAPL ecosystem.

Apple (NASDAQ:AAPL) will report its quarterly results on Tuesday after market close. Consensus expects $3.23 in EPS and $76.66b in revenue. The stock has been down -15% since its last quarterly reporting as the weak read-through from the iPhone supply chain has resulted in several downside revisions from the analysts, which raises the concern that iPhone sales may be reaching maturity and could potentially be facing a structural demand challenge. As I outlined my thesis on AAPL (see - Apple 2016 Outlook: The Sun Can't Shine Every Day), the shift in the carrier distribution model is pushing out the AAPL upgrade cycle and durability of the existing iPhone lessens the need for users to upgrade their handsets on an annual basis. More important, the incremental improvement on the iPhone's hardware is not revolutionary enough for mainstream users to go through an upgrade. While premium Android handsets continue to narrow their gap with the iPhone in terms of both hardware and software, AAPL's market power is at risk.

In the upcoming quarter, iPhone shipments and app store will continue to be major focus areas. As for AAPL's other business segments, Mac is likely to report another low-growth quarter while iPad sales remain weak as tablets continue to lose share to phablet phones. Although AAPL management has often applauded the strong demand for the Apple Watch, the market is waiting for evidence of mainstream traction. Unless AAPL starts to break out the Apple Watch figures, the market will continue to place a heavy discount on this product and focus on the iPhone. I remain cautious on AAPL. My preferences in the North American technology sector are Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB).

Consensus is looking for 77m iPhone shipments with estimates ranging from 75-80m units. Worth noting that over the past two months, consensus has come down from roughly 80-85m to the current estimate. With expectations already lowered, anything short of 75m for the quarter would be a negative to the stock and reinforces my bearish view that the tougher iPhone comps and the shift toward an equipment installment plan by the carriers are negatively impacting iPhone demand. A key question investors should ask is whether the current consensus estimates reflect an accurate picture of iPhone shipments. After conducting channel checks on several North American telecom providers regarding iPhone sales, the conclusion is that the iPhone has not sold as well as many expected, raising the risk that AAPL could miss on iPhone shipments this quarter. In short, iPhone shipments will likely to be the single most important metric for AAPL in the next several quarters and the one key metric that the market will trade on.

Besides iPhone shipments, App Store sales will be another focus given that it is a leading indicator on the health of the AAPL ecosystem. Although I'm a bear on the iPhone, I'm quite positive on the App Store given its solid revenue growth and margin profile. Most notably, despite Android's lead over the App Store in terms of app downloads, the App Store earns 75% more than Google Play in terms of revenue driven by China, Japan and the US that accounted for 90% of the growth for the App Store last year, per data from App Annie.

As for catalysts beyond the quarter, much of the investor attention will be focusing on the reported iPhone6C that is expected to launch in the first half of the year. Investors may be bullish on the prospect of a budget iPhone with metal casing and A9 chip, but I caution that the budget iPhone could potentially support shipment demand at the expense of pricing power and margins as new users gravitate toward the budget model rather than staying on the premium model. The reason is that consumers could enjoy the same ecosystem advantage without paying up for the premium device given that a key attraction toward the iPhone is its ecosystem. That said, I remain cautious on iPhone shipments given the maturing wireless market, the change in carrier distribution and the improvement among premium Android devices.

In the future, I believe that one way to protect the AAPL ecosystem amid stagnating iPhone shipments is to unbundle AAPL's services in music, media, payment and cloud to drive higher penetration (see - Apple: Unbundling To Drive Ecosystem Penetration).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.