Apple share fall may not be bruising

iPhone sales on hold

Investors are likely to reassess the 27% sprint by Apple shares so far this year when U.S. stock trading gets underway on Wednesday. 

That’s because expectations that the world’s most valuable company was about to put a tough year behind it with a resumption of iPhone sales growth have turned out to be premature.

Handset sales were well under Wall St. forecasts of around 52.7 million in Apple’s second quarter, slipping  to 50.76 million from 51.19 million in the same quarter of 2016. iPhone sales, which still account for about 60% of Apple revenue, had apparently stabilised at the start of the year.

In reaction, Apple shares fell about 2% in ‘after hours' trading on Tuesday night having closed mildly higher at $147.51, the latest of several recent record highs.

A handful of factors around iPhone sales could soften the let-down for investors.

Firstly, Apple actually reports ‘sell-in’—AKA wholesale iPhone sales figures, as opposed to retail sales. This practice might be masking a better tally than readily apparent. Obviously, the moderate iPhone sales shortfall relative to expectations could be resolved by up-to-the-minute data too.

Additionally, the group says it sold down inventory of about 1.2 million handsets through its own retail channels, including Apple Stores during the quarter, bringing total handsets retailed closer to analysts' forecasts.

Even without these upsides--and the fact that handset revenues actually rose 1.2%--investors might still conclude there are positive sides to a slightly soft headline iPhone result given that it suggests customers are beginning to anticipate Apple’s long-trailed 10^th anniversary handset update that should hit in the autumn.

Calculated caution in Cupertino

Apple’s major financial results during the quarter were largely satisfactory. A strong earnings per share performance was the highlight. At $2.10, equating to net income of $11.03bn, it topped forecasts of $2.02.

Apple's closely watched gross margin also bettered the street’s view, by about 20 basis points at 38.9 percent – confounding concerns that rising memory chip prices might begin to eat into profitability.

Apple sees the margin in the current quarter between 37.5 percent and 38.5 percent; placing the upper end of guidance above the current investor estimate of 38.3 percent.

Other guidance however, whilst largely aligned with expectations, was either no better or a touch weaker, a concern for Apple investors anticipating the group would soon resume its custom of spectacularly beating estimates.

Sales in the current quarter would be somewhere around $43.5bn-$45.5bn Apple said, whilst analysts had seen £45.6bn. That echoes the slack in revenues against expectations in Q2. They were reported at $52.90bn instead of the $53.02bn pencilled in by investors.

China was reconfirmed as the biggest drag on Apple sales, with momentum of the group’s businesses there continuing to decelerate—this time with a 14.1% drop to $10.73bn, making it around two years since Greater China revenues grew. It was, however, notable that Apple’s CFO, Luca Maestri, struck a conspicuously more optimistic tone on China sales in the earnings conference call overnight, a marked contrast to his tone in prior quarters.

That cheer could still be transferred to investors on Wednesday, despite Apple looking like it's back in the mode of disappointing lofty expectations. It does after all have a formidable arsenal of ways to keep shareholders on side. Its push over the last couple of years to train a brighter spotlight on soaring services revenues is not the least of these. In Apple’s second quarter, software, music and app revenues jumped 17.5% (close to its recent 18%-20% run rate) to $7.04bn.

The group also opened the cash spigot again, lifting its share buyback plans by another $35bn, expanding a separate capital return programme by $50bn, and hiking its quarterly dividend by 10.5%. Such actions will not, of course, materially deplete the group’s ever-increasing cash hoard—which was recently around $250bn.

Perhaps the real risk for investors then, in the wake of the group’s latest results, might not be that they find themselves over exposed to the stock. Instead, it may be that the risk of over estimating the impact of Apple’s soft-around-the-edges quarter is higher.

Apple’s modest market rating of around 16 times the group’s huge trailing 12-month earnings, compared to about 21 times at the S&P 500, may also steady investor nerves.