EUR 850.00 For Business Accounts Only

Morningstar | The Price is Right! Stellar iPhone ASPs Lead to Double-Digit Revenue Growth for Apple's 3Q

Apple's third-quarter results marked the fourth straight quarter of double-digit revenue growth (year over year), led by persistent strength in the iPhone, services, and wearables segments. Despite nearly flat iPhone unit growth, the firm flexed its premium status in the smartphone realm with roughly 20% ASP growth. Loyal iPhone users and many new customers in emerging regions have flocked to the iPhone X, 8, and 8 Plus. Nevertheless, we foresee the upcoming iPhone launch in September likely being more marginal in nature, leading to lower iPhone sales in calendar 2019. We are maintaining our $175 fair value estimate for Apple and would recommend prospective investors seek a wider margin of safety before committing capital to this narrow-moat entity.

The firm generated $53.27 billion in sales for the quarter, up 17% year over year. ASPs for the iPhone grew 20% to $724 from $606 a year ago, led by the iPhone X, 8, and 8 Plus cohort. With iPhone units effectively flat, iPhone sales also grew 20% to $29.9 billion. Geographically, however, Apple enjoyed double-digit unit growth in the U.S., Canada, Germany, and Hong Kong, among other markets. Furthermore, we were pleased to see lower iPhone channel inventory (by 3.5 million units) during the quarter. CFO Luca Maestri noted the firm exited the quarter at the lower end of Apple's target range of 5 to 7 weeks of iPhone channel inventory, which bodes well for the firm's suppliers. Consistent with our narrow moat rating stemming from switching costs, CEO Tim Cook cited data from 451 Research that indicated the iPhone X had a customer satisfaction score of 98%. Wearables (Apple Watch, AirPods, and Beats) saw accelerated growth of 60% driven by iPhone users looking to augment their iOS experience.

Services revenue expanded to $9.55 billion, up 31% over the same period last year. Notably, paid subscriptions from Apple and third parties surpassed 300 million during the quarter and is accounting for an increasing percentage of the services segment. Additionally, this growth was broad-based as each major geographic segment grew double-digits in service sales. Two key subsegments (Apple Music and AppleCare) were pivotal in Apple achieving the gaudy growth figure (though Apple Music remains a considerably smaller percentage, in our view). While Spotify remains the leader in music streaming subscribers, Apple Music now has over 50 million listeners (when combining both paid and trial subscribers), and we believe both streaming services should continue growing at a health clip. Cook corroborated this sentiment, claiming there are less than 200 million music streaming subscribers globally (ex-China).

Gross margins were effectively flat during the quarter (sequentially) at 38.3%, which is a testament to the firm's cost control efforts in light of a seasonally weaker iPhone quarter that typically reduces Apple's leverage. Also, the firm benefited from favorable foreign exchange movements. Despite Apple's ability to raise ASPs on its latest iPhones, we note key input costs have been elevated (memory and OLED displays). Consistent with our view on the memory market, Maestri expects improvement going forward after 12 to 18 months of memory price-induced headwinds. Overall, we think the firm has done a solid job balancing the moving parts of its business to achieve relatively stable margins.

Management foresees fourth-quarter revenue to be at a midpoint of $61 billion, which implies 16% year-over-year growth. We surmise the usual suspects (iPhone and services) will be the key drivers during the September quarter. Similar to this quarter, we think modest iPhone unit growth will be enhanced by meaningful ASP expansion. When evaluating Apple's position in the broader smartphone market, we believe its prestige has led to a more amplified bifurcation with the iPhone X dominating the high-end of the spectrum. Meanwhile, we believe the firm's lower-end SE products have been declining considerably, as iOS users have sought a premium experience despite increasing prices. We think this dynamic will be instrumental to future iPhone success for Apple, with the majority of growth derived from the services and other products business lines. Concerning the escalating trade tensions between the U.S. and China, Cook's commentary didn't suggest any disruption to Apple's product lines. However, he noted ancillary spending for things such as data center may be impacted with the next round of tariffs, though Cook believes cooler heads will prevail.