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Apple - Shares slide as China slows and upgrades stumble

Nicholas Hyett | 3 January 2019 | A A A
Apple - Shares slide as China slows and upgrades stumble

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Apple Inc Com Stk NPV

Sell: 318.07 | Buy: 318.12 | Change 1.38 (0.44%)
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An unscheduled announcement saw Apple adjust its guidance for the first quarter following disappointing trading in emerging markets and fewer iPhone upgrades.

Revenues are now expected to be just $84bn in Q1, down from previous guidance of $89bn-$93bn. Gross margin and operating expenses are both now expected to be at the lower end of guidance.

The shares fell 7.6% in after-market trading.

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Our view

In August last year, Apple became the world's first trillion dollar company.

Success has been built on a series of ground-breaking products, which garnered Apple an unrivalled reputation for product innovation. 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 particularly in China. That's a concern because iPhone sales make up 59% of total revenue and China has been a key growth market.

The problem is being made worse because Apple has continued to hike prices to the point where a top model can 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, especially as the global economy is looking wobbly.

The twin headwinds of tougher competition and a more price conscious consumers probably explain why the shares have fallen to a P/E ratio of just 11.6 times, some way below their long run average.

But it's not all doom and gloom. Apple has continued to grow its installed base and we think that's due to successfully positioning 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.

That's because the mushrooming Services division is now driving growth.

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 the billion or so Apple products in use, rather than focussing on new sales. Whether that's through individual subscriptions to its music service or by charging app developers license fees for using the App store, the division should provide a steady flow of revenue.

Over the years the group has 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.

Apple is midway through a monstrous share buyback program, and offers 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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Trading update

Apple' has anticipated weakness in emerging markets, but this had ended up having a much more significant impact on sales than expected. This is driven by particular weakness in China - where growth during the September quarter was the second slowest in 25 years.

This resulted in lower iPhone sales, which accounts for all the revenue shortfall against guidance. Categories outside iPhone, which includes Services, Mac, iPad, Wearables/Home/Accessories, actually grew by a combined 19% year-on-year.

However, iPhone upgrades have also been weaker than expected in some developed markets, which the group attributed to higher pricing and reduced pricing for iPhone battery replacements.

The total installed base grew by more than 100 million units in the last 12 months. As a result Service revenues hit $10.8bn during the quarter, hitting a new quarterly record.

Apple has guided for gross margin of 38% in the first quarter, with operating expenses of approximately $8.7bn.

Despite the headwinds, profitability and cash flow generation remain strong and the group expects to end the quarter with net cash of $130bn.

Find out more about Apple shares including how to invest

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.