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Apple - iPhone sales under fire, but Services to the rescue

George Salmon | 30 January 2019 | A A A
Apple - iPhone sales under fire, but Services to the rescue

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Apple Inc Com Stk NPV

Sell: 318.07 | Buy: 318.12 | Change 1.38 (0.44%)
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Apple's first quarter sales are down 5% year on year at $84.3bn, with iPhone sales, particularly in China, weighing on results.

However, the numbers are in line with the revised guidance issued earlier this month.

The shares rose 5.7% in after-market trading.

The quarterly dividend is $0.73 per share, up from $0.63 last year.

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Our view

Apple's success was built on a series of ground-breaking products, each more innovative than the last. Unfortunately it's been a while since we've seen anything truly revolutionary - and the competition is catching up.

That's particularly true in smartphones, and especially in China. That's a concern because iPhone sales make up the lion's share of total revenue and China has been a key growth market.

A top iPhone can now cost over $1,000. With cheaper batteries making existing iPhones last longer, and rivals closing the technology gap at a fraction of the price, it's harder for customers to justify the extra expense.

External factors are hardly helping either. The economic backdrop remains uncertain and the battleground in the ongoing trade war between the US and China has turned to tech.

These headwinds probably explain why the shares have fallen to trade on just 12.5 times expected earnings, 12.7% below the longer run average.

But it's not all doom and gloom. Apple has successfully positioned itself as an aspirational, yet accessible brand. In fact, in our view, the strength of this brand has supplanted innovation as the group's trump card.

The mushrooming Services division is helping Apple cash in.

CEO Tim Cook's spent years espousing the virtues of this division, which includes Apple Pay, Apple Music and the App store. We're finally starting to see why. Revenues have been growing rapidly, and it's now comfortably Apple's second largest division by revenue.

Services is exciting because it opens up the possibility of monetising 1.4bn Apple products in active use. Through individual subscriptions to its music service or by charging app developers to use the App store, the division should provide a steady flow of high-margin revenue. That could take the pressure off the group to deliver constantly rising hardware sales.

The group has historically generated shed-loads of cash. Until recently, that had just been hoarded on the balance sheet. A change in policy means it's now finding its way back to shareholders.

There's an ongoing share buyback program, and the shares offer a prospective yield of 2%. That may not be large, but it's more than others in the US tech sector.

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Q1 trading details

Apple delivered a gross margin of 38% on its $84.3bn of sales. After deducting operating expenses, that led to an operating income of $23.3bn in the quarter - down 11.1% on Q4 last year.

However, the ongoing share buyback plan and a lower tax provision helped diluted earnings per share rise 7.5% to $4.18. Looking ahead, the group expects to deliver $55bn - $59bn of revenue in Q2 with a gross margin between 37 and 38%.

iPhone sales were down 15% to $52bn in the quarter, but remain the biggest component of group revenue. Sales of other products rose by a collective 19% to $21.5bn. Mac, iPad and wearable tech like the Apple Watch, all saw sales increase. Total product gross margin was 34.3%.

Apple's services business continues to grow, with revenues rising 19% to $10.9bn. Gross margin was 62.8%.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.