Apple – Cycle economics

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The end of the iPhone 6 product cycle is normal and expected.

• It is starting to appear that the iPhone 6s is performing as I have been expecting rather than as the bulls are hoping.
• The last week has seen a raft of signals coming from the supply chain that instead of continuing its very rapid growth, iPhone sales are beginning to flatten out.
• I view this as a completely normal event as product cycles never last for ever.
• This began with Dialog Semiconductor’s poor revenue guidance for the coming quarter and has continued with the curtailment of hiring plans by one of its biggest assemblers (Pegatron) as well as chatter surrounding softening of iPhone demand in China.
• Dialog and Pegatron have 79% and 49% of their revenues respectively coming from Apple meaning that any unexpected revenue volatility is likely to be due to fluctuations at Apple.
• I think that this issue has everything to do with suppliers’ and analysts inability to make accurate forecasts and very little to do with Apple itself.
• I have long been of the opinion that for the last year that Apple’s strength has been driven by a product cycle rather than secular change.
• The iPhone had been long criticised for having a small screen and Apple’s rectification of this issue released a lot of pent up demand.
• The result was a gain in market share at the high end as users switched from Android across the world.
• A product cycle consists of an abnormal level of shipments of a product that then subsides when most addressable users have adopted the product.
• It looks like this is beginning this quarter and I suspect that Apple is more than aware of this issue and has already taken the appropriate action both internally and with its guidance for FY Q1 16E.
• This fits with my forecasts where I am looking for 72.9m iPhones to ship in Q4 14E which is up 27% from Q3 15A but down 3% YoY.
• Hence, I think the curtailment of hiring at Pegatron, reported weakness in Chinese demand for the iPhone and Dialog’s poor forecast is simply a manifestation of poor forecasting rather than an abnormal problem with demand for iPhones.
• This puts Apple back in the position where it has to address a new product category in order to see another leg of real growth.
• The new Apple TV should help but its volume and price are way below that of the iPhone meaning that its ability to drive growth will be very limited.
• Consequently, I think that the growth in revenues and profits for this product cycle are over and I can see the bulls having to temper their enthusiasm somewhat.
• The good news is that Apple’s valuation remains pretty undemanding as it is trading on just 7.7x 2016 PER once the fact that Apple’s cash balance makes up one third of the valuation of the shares is taken into account.
• Hence, I do not see a big correction coming but at the same time I don’t see substantial upside either.
• Apple remains a good place to park cash but I would look at Microsoft, Facebook or Samsung for upside potential.