bulls swooned last week over the company’s better-than-expected reported earnings. All it took was a return to revenue growth after two quarters of declines. The definition of success has changed for the iPhone maker, which spent a decade growing sales more than 20% a year on average.
A return to sales growth in the latest quarter was an important inflection point for Apple (ticker: AAPL), but the negativity could return as investors dig into the underlying realities.
On Tuesday, Apple reported June-quarter revenue of $53.8 billion, up 1% year over year and above the consensus forecast of $53.3 billion. Earnings per share were $2.18, down from $2.34 the prior year but higher than the $2.09 average analyst estimate. The shares rose 2% the following day, with multiple analysts raising their Apple stock price targets.
The upside came from surprising areas. Sales from the Mac business beat Wall Street’s estimate by about $400 million, while the Wearables, Home, and Accessories operation crushed estimates by $700 million. That segment includes the Apple Watch and AirPods. While the tech giant doesn’t disclose sales in the segment, Cook did say last week that wearables grew “well over 50%” in the quarter. AirPods sales probably benefited from a revised version released in late March.
But investors should be careful in evaluating the shifting narrative. The long-term driver of Apple shares has been excitement about the company’s services businesses. The stock move is clear on that: Apple is up nearly 30% this year, even as iPhone sales have declined markedly.
The stock now trades at 16.4 times projected earnings for the next 12 months, well above its five-year average of 13.7 and near a five-year peak of 17.7. Investors have been paying up for the stock on the idea that Apple is moving away from its hardware focus toward a more predictable services- and software-driven model.
The problem is that Apple’s services business remains a question mark and could still disappoint. The segment actually missed analyst estimates by $200 million in the June quarter, with sales up 13% year over year, versus 16% in the prior quarter.
Moreover, KeyBanc Capital Markets Andy Hargreaves expects Apple’s services growth rate to subside over the next year. “Services business is tied to growth in the user base,” he says. “And the user base is definitely decelerating.”
The dynamic puts even more pressure on Apple’s next wave of services, expected to be launched by the end of the year, including Apple TV+ (video subscription), Apple Arcade (gaming subscription), and Apple Card (credit card). In each area, Apple is joining a crowded field. “What Apple is offering is not going to be better than what’s in the market,” Hargreaves says.
Amid the excitement about wearables, iPhone sales came in below expectations for the quarter. The iPhone’s revenue of $26 billion missed the Street consensus by $300 million, with sales down 12% year over year. IPhone unit sales, which Apple no longer discloses, might look even worse. IDC estimates that iPhone unit shipments were down 18% year over year in the quarter, the worst showing among the top five global smartphone makers. Apple didn’t respond to a request for comment on IDC’s data.
“The core controversy of normalized iPhone growth remains unresolved,” Bernstein analyst Toni Sacconaghi wrote on Wednesday. “We remind investors that iPhones are still down, [and] big questions about replacement cycles [are] still outstanding.”
Apple’s new iPhone lineup, due this fall, is unlikely to change the story significantly. “This [coming] cycle, I believe, will be challenging, as I am not expecting dramatically new designs,” Patrick Moorhead, principal analyst at Moor Insights & Strategy, wrote in an email.
And then there’s trade. Apple is arguably more exposed to China than any other large U.S. tech firm.
On the recent earnings call, CEO Tim Cook downplayed reports that the company is moving production out of China, where it largely manufactures its products, to avoid potential tariffs. “There has been a lot of speculation around the topic,” he said. “I wouldn’t put a lot of stock into those.”
Apple is clearly worried about tariffs, however. In June, it sent a letter to U.S. Trade Representative Robert Lighthizer, noting that the next round of proposed tariffs would hurt it because it would cover all of Apple’s major products, including the iPhone, iPad, Mac, and AirPods. “We urge the U.S. government not to impose tariffs on these products,” Apple wrote. “U.S. tariffs would also weigh on Apple’s global competitiveness.”
The letter wasn’t convincing enough. On Thursday, President Donald Trump announced plans to impose a 10% tariff on Sept. 1 covering $300 billion in imports from China—including Apple’s key products. Investor reaction was swift; Apple closed down 2% on Thursday and another 2% on Friday, to $204.02.
While the latest tariffs may just be a negotiating tactic, any possibility of trade levies doesn’t seem reflected in Apple stock.
So where do Apple shares go from here?
In early January, a few days after the company had issued a sales warning and with its stock reeling, we said the pessimism had gone too far, arguing that the shares could rise 30%, to $194. The bullish call proved correct, with the stock hitting that mark in March.
From there, we warned that the stock’s 2019 gains could fade as investors returned their focus on the declining iPhone sales. Our view hasn’t changed. Apple is richly priced, just as conditions seem to be deteriorating.
Write to Tae Kim at email@example.com