Tuesday, July 26, 2016
Our Apple fiscal Q3 earnings preview is going focus exclusively on the topic of Apple's guidance as everting rests on the numbers Apple delivers relative to Q4 expectations. Guidance is EVERYTHING. When Apple reported fiscal Q2 earnings, it already told us essentially what it was going to report for fiscal Q3. Thus, unless we get a miss or a blowout, the actual fiscal Q3 numbers matter a whole hell of a lot less than does the guidance for Q4. Now if Apple were to blowout earnings and then offer shitty guidance, forget it. It won't matter. How the stock reacts to that is not obvious. Either the stock takes a hit if Apple delivers low guidance with a blowout report or the market views everything as being priced in at this point and the stock rallies. At some point, what Apple reports in its earnings won't matter and the stock will rally regardless of the report. For example, suppose Apple were going into this report at $78 a share. If that were the case, I don't think anything Apple reports will matter. The stock will have likely bottomed and gearing up for a rally regardless.
II. Apple COULD Bottom even with Horrible Earnings
If you go back and fiscal Q3 2013, Apple delivered its worst revenue growth in the company's post-iPod history and delivered horrible guidance; AND YET -- the stock bottomed and began its multi-year rally. Apple's revenue growth fell to 0.90% that quarter (Q3 2013). That was the lowest Apple had on record going back to the pre-iPod era. And it's guidance for fiscal Q4 2013 was horrible. The company modeled for flat year-over-year growth, and wound up reported 4.19% growth by the time it had delivered its fiscal Q4 results. It then molded for FLAT to NEGATIVE GROWTH for Fiscal Q1 2014. Think about this for a moment. What if I were to tell you that Apple would deliver a shitty Q3 revenue report, guide for negative growth for fiscal Q4 and then again for fiscal Q1. Would you think Apple will have bottomed? Probably not. Yet, we saw precisely that. Apple had reported LOW SINGLE DIGIT growth FOR AN ENTIRE YEAR while rallying. Everyone thinks Apple needs to provide some sort of a catalyst for bottoming. Well the history blatantly says otherwise. Take a look at this chart below which will be the focus of our discussion in this section.
Did you know that Apple had reported 58.43% revenue growth ahead of its top in 2012? In fiscal Q1 2012, Apple reported 73.27% revenue growth. In fiscal Q2 2012, it followed up with 58.43% revenue growth. All the while, Apple's valuation never rose above an 18 P/E ratio. In fact, Apple regularly traded between a 15 and a 18 P/E ratio during that entire year. There was no reason to expect Apple to top out and crash back then. Even with a slowdown in revenue and earnings because it's valuation was never high to begin with.
In fiscal Q3 2012, the revenue growth fell to 22.58% and that is where the stock topped out. By the time Apple reported its fiscal Q4 2013 earnings, Apple was trading under $600 a share. Apple's report was nothing that bad. It's revenue growth ticked up to 25.23% and it guided for 15% revenue growth for fiscal Q1. Notice Apple as trading at around a 12-13 P/E ratio at this point. Yet, the stock crashed nonetheless. And here's why. While Apple delivered a 17.65% revenue growth rate for fiscal Q1 (not that bad), starting in fiscal Q2 2013, we started to see some really low numbers. In fiscal Q2 2013, revenue growth fell to 11.27% and then crashed out finally at 0.90% for fiscal Q3. Apple's stock bottomed and began a 1-year long 100% rally despite the fact that Apple's revenue and earnings continued to suffer all year long. Apple posted growth rates of only 4.19%, 5.65%, 4.69% and 5.88% for the next four quarters respectively. Think about that and compare to today's situation.
People think Apple needs some sort of a catalyst or that Apple has become a "show me stock." I think this is a huge fiction. Apple historically has never bottomed and began a rally on any such thing. In fact, nearly every crash happens while Apple reports stellar growth ahead of what will be a weak set of quarters and begins to rally all while earnings are shitty ahead of what appears to be strong future growth. There has never been a time where Apple needed to 'demonstrate' to the market that it could grow.
Back in 2013, Apple rallied throughout 2013 and 2014 because the market expected that the iPhone 6 would represent a super cycle and it did. While revenue growth was sitting at 5% or under for the four quarters that Apple rallied 100%, once Apple released the iPhone 6, revenue growth skyrocketed. Beginning in fiscal Q4 2014 and peaking in fiscal Q4 2015, Apple's revenue grew in the double-digits for five consecutive quarters at 12.35%, 29.53% (Q4-15), 27.06% (Q2-15), 31.02% (Q3-15) and 22.33% (Q4-15). Now here is something astonishing. Apple rallied thought the neater single-digit growth phase for four consecutive shitty quarters and then it topped after delivering THE VERY FREAKING FIRST STRONG QUARTER. Think about that for a moment. Apple reported a massive 29.53% growth rate when it delivered its Q1-2015 earnings report at the end of January 2015. Yet, by February 2015, the stock completely topped out. It traded sideways to down all while reporting 30% growth rates for the next few quarters. In fact, after reporting a 27.06% growth rate in fiscal Q2 Apple trended lower. And then after reporting a 31.02% growth rate -- the highest rate of the year -- the stock crashed 30% over the next 2-months. It reported a 23.33% growth rate for fiscal Q4 2015 and crashed even further. Why? Because the market anticipated the 1.76%, -12.76% and -12.20% growth rates for the next 3-quarters.
Ok. So what does this trend show you? Does it show you that the stock crashes after delivering weak reports and then rally after delivering strong reports? Nope. Not even close. In fact, Apple rallied between July 2013 and February 2015 delivering mostly shitty reports and topped on the very first strong report. In bottomed 2013 ahead of what was four consecutive quarters of sub-5% revenue growth. And trust me, revenue is the only really important thing here. A company's earnings really is very pliable and could be fixed. What can't be fixed is revenue. Revenue is the most important measure of a company's well-being. That's why Amazon is able to rally to all-time highs every day despite it's crap earnings. It's due to its strong revenue growth.
So here is the main takeaway from this section. Even if Apple delivers crap earnings and gives crap guidance, the stock could just bottom out because the market decides it wants to look ahead to the iPhone 8 super-cycle for the fall of 2017. In fact, from a time perspective, this is exactly the quarter that Apple bottomed out at ahead of the iPhone 6 which was a year away at that point.
That's the take away here. Apple has never been a "show me stock." The last time it crashed, it did coming off of a 73.27% and 58.43% revenue growth rates and the last time it rallied, it did so going into five quarters of horrifically low growth: 0.90%, 4.19%, 5.65%, 4.69% and 5.88%. Yet, it rallied because the market had already priced in that year of shit growth and decided to start pricing in the iPhone 6. By the time the iPhone 6 hit the market, Apple's stock had completed something like 80% of its stock gains. If one were to wait for the iPhone 8 to be delivered, they can expect mostly all of the gains to already be had. That's the point.
So this is argument #1 for why it may make sense to hold Apple's stock going in to earnings. The stock may bottom regardless of what it reports because Apple has a history of pricing in negativity well before it happens and it has a history of pricing in growth well before it ever happens. Apple was rallying for five quarter of negative growth BECAUSE after that period it saw five quarters of significant growth. It topped in the second quarter of that growth phase. And now we're at the trough again.
And here is another point which is very important. Even if Apple were to sell-off on fiscal Q4 earnings, we've seen Apple then bottom out shortly thereafter and begin a multi-month rally. So we could see a situation where Apple does indeed gap-down to like $94 a share, sell-off back down to $90 again and then it could rally up to $120 over the next 6-8 weeks. That can very easily happen and has happened before. In fact, we've seen years where Apple was down 10% on fiscal Q3 earnings and then hammered interday to close in the green. That's on earnings day -- I believe that was fiscal Q3 2007 or 2008 that we saw that happen. It was one of those years.
If you look at Apple's fiscal Q1 2016 earnings report, the company went into the results at $99 a share, it fell on earnings, tested $90 one last time and then rallied to $113 over the next 5-weeks. So the point is that EVEN IF Apple were to gap-down after earnings, we are going into iPhone season and evidence suggests that Apple may introduce that device earlier than usual this year -- we'll get to that.
III. Was guidance for fiscal Q3 overly conservative?
There is the possibility that Apple's guidance for fiscal Q3 was overly conservative. There is some evidence that might suggest this is the case and then there is also evidence that counter's this. Let's start with the evidence suggesting that fiscal Q3 revenue and earnings forecast might have been overly conservative even for this management team that tries to forecast accurately (rather than conservatively).
Not a single iPhone 5SE sale was recorded in fiscal Q2. Not one. Apple introduced the iPhone 5SE going into this quarter. So all of that demand we've heard about is all happening during his fiscal Q3 quarter. Here is what Tim Cook said on the fiscal Q2 conference call regarding the iPhone SE:
We announced some fantastic new products during the March quarter. IPhone SE became available on March 31, so none of its sales were reflected in our second quarter results. But so far this quarter we're seeing terrific customer response. IPhone SE is the most powerful four-inch phone ever, and it's a great option for customers all over the world who want a compact phone with advanced features and a great price without compromising performance. Demand has been very strong and exceeds supply at this point, but we're working hard to get the iPhone SE into the hands of every customer who wants one as quickly as possible. The addition of the iPhone SE in the iPhone lineup places us in a better strategic position to attract even more customers into our ecosystem.
Notice he said the supply is outstripping demand and that the demand has been 'very strong.' He comments consistently during the fiscal Q2 conference call about how the iPhone SE is doing well.
Toni Sacconaghi from Sanford Bernstein & Co. brought up a very good point on the conference call which may suggest that guidance for fiscal Q3 may have been a tad bit conservative. Take a look at Scconaghi's question here:
Yes, thank you. I have one and then a follow-up as well. My sense is that you talked about adjusting for the changes in channel inventory, that you're guiding for relatively normal sequential growth. And I think if you do the math, it's probably the same or perhaps a touch worse in terms of iPhone unit growth sequentially relative to normal seasonality between fiscal Q2 and Q3. I guess the question is, given that you should be entering new markets and you should see pronounced elasticity from the iPhone SE device, why wouldn't we be seeing something that was dramatically above normal seasonal in terms of iPhone revenues and units for this quarter?
It's a good question. If the iPhone SE was introduced on March 31 -- right at the beginning of the quarter -- and the demand is strong for the device, then why such a sharp year over year decline and why such a sharp sequential decline. It's one thing to see year over year declines compared to a strong year, but another to expect stronger sequential decline than usual. We're in the same fiscal year right. So why would we expect to see a strong sequential decline or above normal sequential decline when Apple just introduced a new class of iPhone? Here is Tim Cook's response:
Toni, it's Tim. Let me see if I can address your question. The channel inventory reduction that Luca referred to, the vast, vast majority of that is in iPhone, and so that would affect the unit compare that you may be thinking about. The iPhone SE, we are thrilled with the response that we've seen on it. It is clear that there is a demand there even much beyond what we thought. And so that is really why we have the constraint that we have.
Now here's what Tim Cook is referencing with channel inventory. Apple decided to take a $2 billion drawdown in channel inventory for fiscal Q3 which represents $2 billion in revenues for the company. If the company didn't draw down that inventory, then it's guidance would have been $2 billion higher. This compares to fiscal Q3 2015 (last year) where Apple drew down its inventory by $800 million. So there's a $1.2 billion disadvantage right off the bat for fiscal Q3. Meaning, when you compare fiscal Q3 2015 to fiscal Q3 2016, you need to do so after adding $1.2 billion to Apple's revenue. That is Tim Cook's reason for why Apple is expecting a weaker than usual fiscal Q3. They plan to draw down inventory ahead of the iPhone 7 launch -- more than usual in fact.
Yet, here is why I think the guidance may be conservative notwithstanding. Apple just missed on revenue and earnings for fiscal Q2. You would think that after missing, they would be a tad bit more conservative with their estimates or at least be a little gun-shy on the high end of the estimates. Now here's something I have't done but maybe we can crowd source it. If someone wants to take on the following project, I can put the data into chart form. I would like to see how Apple has reported -- revenue wise -- relative to their guidance in past quarters. IF we can get a sense of how Apple has performed relative to its revenue guidance for the past several years, we can get a sense of what happens when Apple misses or comes in light.
Also, consider that if Apple is being conservative, the historical range would give you a sense of a ceiling to that conservatism. Because while Apple may have been a little gun-shy after missing in fiscal Q2, the company will only be conservative to a point.
Ok. So to conclude this section, here's the evidence suggesting conservatism. First, the Apple iPhone SE was introduced at the outset of the quarter and we haven't seen any sales recorded. Apple suggested demand was strong and that they were working to get into supply-demand parity. Second, Apple did miss on fiscal Q2 earnings and so it's possible Apple may have over-corrected to the conservative side.
Arguing against this is the fact that Apple plans on drawing down its inventory levels by $2 billion in revenues. That's quite significant cut. It could be argued that the cut in channel inventory will off-set any gains to be had from the iPhone SE. Also arguing against this conservatism is the fact that the dollar rallied pretty hard with the Brexit. So it's possible Apple's revenues could come in very light as a result of the Brexit. Then again, Apple may have priced-in the Brexit and anticipated the currency results ahead of it. Apple does currency hedge and does focus on what's happening in currency markets.
The other counter-argument is that Apple has a policy of simply just offering what it expects it will earn with any varnish whatsoever. That means not being overly conservative after missing or becoming aggressive after blowouts. That it's the unknowns of the quarter that leads to the beats and misses. So that when Apple did offer it's guidance at the time it did offer that guidance, management was not intending to be conservative. Tim Cook has commented on this more than once in previous calls. They try to just give the market whatever numbers management actually believes it will reports w/o sandbagging.
Net-net I do think its human nature to be conservative regardless of how "accurate" you want to be after you just missed. Whatever numbers go into their calculation, you can bet they were rounding down and not up. And it wouldn't surprise me if they completely wrote off the iPhone SE given the environment. So that could have been a lot stronger than anticipated and that could lead to a beat.
IV. Apple may have set-up fiscal Q3 to be the 'trough'
There's a possibility that Apple's management may have intentionally set-up fiscal Q3 2016 earnings to be the trough or low point in the negative growth rate cycle. When Apple reported its fiscal Q1 2016 earnings, Tim Cook said he believed that fiscal Q2 would be the 'trough' or low-point in this negative environment for Apple. In his prepared remarks, he said he believed that 'the March quarter faces the most difficult year-over-year compare relative to the rest of the year." He repeated that at least twice in the conference call.
Now here is why I think this comment is a lot more significant than it might appear. No one even mentioned or bought this up in the fiscal Q2 conference call three months later. No one even really brought it up. Someone did inadvertently and barely hinted at this and Tim Cook immediately brought up his own comment on the call in his response. This I think is a little telling because it means that Tim Cook for three months remember his own comment about Q2 being the trough. He was sensitive enough to the comment that he brought it up himself during the fiscal Q2 call. Take a look at this exchange:
Rod B. Hall - JPMorgan Securities LLC
Thanks, guys, for fitting me in. I wanted to start with a more general question. I guess. Tim, this one is aimed at you. As you think about where you thought things were going to head last quarter when you reported to us and how it's changed this quarter, obviously this kind of a disappointing demand environment. Can you just help us understand what maybe the top two or three things are that have changed, so as we walk away from this we understand what the differences are and what the direction of change is? And I've got a follow up.
What? This question is so general it's not obvious what he's really hinting at and yet, Tim Cook decides to bring up his own comment from the Q1 conference call on his own. Notice this is three months later. Meaning, Cook must have given his comment some thought at some point, he remembered making it and brought it up himself without anyone even hinting at it. IN FACT, and this is a biggie, Cook even admits that he believes that Mr. Hall indirectly referred to the "trough" comment Cook made in the Q1 call. Here's how Tim Cook responded:
I think, Rod, you're probably indirectly asking about our trough comment, if you will, from last quarter. And when we made that, we did not contemplate or comprehend that we were going to make a $2 billion-plus reduction in channel inventory during this quarter. And so if you factor that in and look at true customer demand, which is the way that we look at it internally, I think you'll find a much more reasonable comparison.
So here's the thing. I think this comment here suggests to me that Apple may really be setting up fiscal Q3 to be the trough. At some point, Apple is going to return to growth. Right now, the market is molding for double-digit negative growth for fiscal Q4 and very low growth for fiscal 2017.
Now think about what this $2 billion drawdown in channel inventory does. First, it leaves a temporary gap to fill at a future point. Second, it artificially deflates fiscal Q3 because you cannot compare it to a quarter where Apple only took an $800 million channel reduction. Right off the bat, this quarter is at a $1.2 billion disadvantage to fiscal Q3 2015. What's more, fiscal Q3 2015 was the third quarter into the iPhone cycle and actually represented the peak in revenue growth of the year. If you scroll up and look at the chart above, you can see the 31% revenue growth Apple experienced in fiscal Q3 represented the peak in growth percentage wise. So that does make fiscal Q3 a tough compare period. But when you add the $1.2 billion net reduction in channel inventory, it really sets up Q3 to be a weak quarter -- and it sets up fiscal Q4 to be a strong quarter.
Notice the second the market sees a shift in earnings to the upside indicating that we've hit a trough on earnings, the stock will start to rally as we outlined in sections I-II above. All Apple needs to do is report in-line with expectations for fiscal Q3 and then offer a positive spin to fiscal Q4 and the stock will rally. The $2 billion reduction in channel inventory is going to be filled right back up in fiscal Q4 with iPhone SE's and with iPhone 6's that Apple plans to continue to sell along side the iPhone 7 (as it has done historically).
So the take away here is this. Tim Cook is cognizant or sensitive to his comments about fiscal Q2 being the trough. Apple decided to draw down its channel inventory in fiscal Q3 and stated mere prudence as the reason. They didn't give any specific reason for the reduction beyond they just want to be "prudent" given the macro environment. That means it could be for any reason they want which could include to trough Q3 intentionally.
What's more, with Apple taking a $2 billion haircut to channel inventory, it sets up Q4 to rebound as Apple refills that channel.
V. Fiscal Q4 Analyst Expectations are Dangerous
Initially, when looking at Apple's fiscal Q4 expectations and noticing the massive 11% revenue decline expected by analysts, my reaction was to think that maybe expectations are way too low. But now that I've done a lot more digging on the issue, I actually think that analyst expectation may be too high now. It may also be perfectly fine. It's odd, in some ways, the expectations are high. In other ways, maybe not. You be the judge. I'll lay out the issues.
So right now, analysts are expecting Apple to report fiscal Q3 revenues of $42.11 billion. This compares to the $41 to $43 billion guidance that Apple gave analysts when it reported fiscal Q2. So analysts are literally right at the mid-point of Apple's revenue guidance for the quarter.
Now here's the problem as I see. For fiscal Q4, analysts are modeling for $45.84 billion in revenue. That would represent an 8.85% sequential growth rate b/w fiscal Q3 and fiscal Q4. Now obviously this sequential growth rate assumes that Apple merely reports $42.11 billion in revenues.
What I don't like about the estimates is that analysts have been really disingenuous with their estimates. Hers's why. If you actually believe that Apple will only report $42.11 billion, then you shouldn't be modeling for $45.84 billion for fiscal Q4. The modeling of $42.11 billion for fiscal Q2 suggests a much lower estimate for Q4. Why? Because the sequential growth rate b/w fiscal Q3 and fiscal Q4 generally around 3-5% -- not the 8% being put forth by analysts here.
In fact, the best sequential growth rate we've ever seen between fiscal Q3 and fiscal Q4 is 12% with the launch of the iPhone 6. That's a pretty major dick move by analysts because they padded their Q4 numbers so that if Apple were to beat, it would be difficult for Apple to give estimates above the street for Q4. With the street being at $42.11 billion, they really should have been at around $43.4 billon for fiscal Q4. that gives Apple ample room to guide above estimates and ample room to beat those estimates. But at a $45.84 billion, it sets Apple up to come in-line or slightly above at best. At least that's one argument.
ON THE OTHER HAND, we have to remember that there's a $1.2 billion discrepancy between fiscal Q3 2015 and fiscal Q3 2016 in terms of channel inventory. If we add the $1.2 billion into the quarter, then analyst expectations are really for a 5.84% sequential rise. That's actually in-line with last year's 5.10% sequential rise. Now what's interesting about last year is Apple's quarter ended only two days after the launch of the iPhone 6S. So that 5.10% sequential rise in revenues was actually pretty impressive considering they didn't get the full benefit of the iPhone 6S launch. Take a look at the chart below. This chart shows the sequential growth rate between fiscal Q3 and fiscal Q4 going back to 2006. Notice that Apple didn't start launching the iPhone in the fall until the Phone 4S was released. Apple launched the iPhone 1 at MacWorld 2007 and released the iPhone 3G, 3GS and 4 during the WWDC in June 2008, 2009, and 2010. It then started to announce the iPhone in a separate event in the fall with the iPhone 4S, 5, 5S, 6 and 6S. So keep that in mind when looking at these sequential growth rates b/w fiscal Q3 and fiscal Q4:
Now here are some further arguments for why we may see another record sequential rise in revenues. Let's go year by year and explain some differences. Last year, Apple posted a 5.1% sequential rise in revenues. This in spite of Apple only recording 2-days of sales for the iPhone 6S. In some ways, the reason for this growth in spite of only being able to post 2-days of iPhone sales is that perhaps there was strong sell-throngh for the iPhone 6. This was only the fourth quarter of sales of the larger iPhone. And demand was very strong throughout the year and even into parts of the iPhone 6S.
Remember, the first weekend of sales of the iPhone 6S were stronger than the first weekend of sales for the iPhone 6. Apple sold a record breaking 13 million iPhones in the first weekend of iPhone 6S sales whereas it only sold 10 million iPhone during the launch of the iPhone 6.
Another thing to note is that the first weekend worth of sales represented 27.1% of fiscal Q4 2016's iPhone sales. Apple sold a total of 48 million iPhones in fiscal Q4 2015 and 13 million of those may have mostly came from the launch. Technically, the quarter ended before Sunday, September 27, 2015. The quarter ended on September 26, 2015 and included that 26th day as part of the quarter's sales. So the question is really how many iPhones were sold on Sep 27.
The point is this. That weekend did have an impact and that impact would have been even stronger had Apple sold the iPhone for 8-9 days out of the quester like it did the iPhone 6, iPhone 5S, and iPhone 5. All three of those iPhones sold for 8-9 days before the quarter ended.
Now this is important for two reasons. First, there is an increasing amount of evidence to suggest that the iPhone will go on sale on September 16 of this year. That would be 8-days before the quarter ended. Second, fiscal Q4 2015 may have actually been weaker than it would have been had Apple been able to sell the iPhone 6S for the a longer period of time.
My point is that we may see a much stronger comparison than fiscal Q3 2016. Right now, analysts are modeling for 15% negative revenue growth for fiscal Q3 and 11% negative revenue growth for fiscal Q4. It's possible with the drawdown in channel inventory in fiscal Q3 coupled with Apple launching the iPhone earlier in the quarter that we may get a better compare. Maybe Apple is able to cut that negative rate to 5% or less.
Let's do some math here. Suppose it's discovered that Apple was indeed conservative and reports $43.5 billion in revenue exceeding its top-line revenue number. If we then add back $1.2 billion in channel inventory to the quarter, Apple would have reported $44.7 billion from a demand point of view.
Add to that the fact that Apple may be selling the iPhone 7 for 5-6 more days than fiscal Q4 2015 sold the iPhone 6S. With those extra 5-6 days of sales, we may close the iPhone gap very rapidly. Even if Apple were match the first weekend of sales for the iPhone 6S, historically, the first weekend of sales has represented roughly a quarter of the total on the quarter. Meaning, Apple could very well report 45 million iPhones on the quester and close that gap a lot more than one might think.
A lot of things can very easily align in this manner. It's not outside the realm of possibility that Apple could actually eclipse fiscal Q4 2015. Meaning, we may not even see negative growth at all. Consider this. The installed base as of the end of fiscal Q2 2016 has grown 80% since the launch of the iPhone 6. During this iPhone 6 to iPhone 6S period, Apple saw its iPhone user base grow by 80%. Think about that. And that's just in a year and half. We're talking only through the month of March. That installed base is much larger now with the Android switcher rate being at around 30%.
Apple made it clear that the iPhone 6S upgrade cycle was greater than the iPhone 5S cycle. Meaning, if you take all of the iPhone users and look at upgrade rates to the iPhone 5S on a percentage basis, we had more people upgrading during the iPhone 6S cycle, than we did during the iPhone 5S cycle. Interestingly enough, I'm part of that statistic. The ONLY iPhone i didn't own was an iPhone 5S. I skipped it altogether.
Now with 2-year contracts ending in the fall, we could very well see a perfect storm here. The iPhone 7 may be better received and with people out of contract with a 2-year old phone -- many many friends and family included -- it wouldn't surprise to see a strong showing. Apple has the best sense for these things too.
So on the one hand, the estimates on purely objective number basis are higher than they should be. If analysts are really expecting $42.11 billion, they should be a lot lower. On the other hand, we have all of these other factors at play. WE have a net $1.2 billion drawdown to channel inventory relative to 2015. The number is $2 billion but when we compare sequential rates, it's best to consider what the inventory drawdown was in the year prior.
In 2014, Apple launched the iPhone 6S only two days before the quarter ended. Presumably if Apple launches the iPhone 7 on September 16, then we should see much stronger sales this year. Apple will get a 7-day advantage of iPhone 7 sales over fiscal Q4 2015.
Also, you have to remember that people are coming off 2-year contracts and this is a new form factor phone. It's the 7 as opposed to the iPhone 6S which was exactly the same as the iPhone 6 (with minor feature differences).
The risks, as I see it, is the launch. If Apple doesn't launch the iPhone 7 a week before the quarter ends, then it's a lot tighter. Keep in mind that I think at worst, Apple launches it the same time it did last year and the stock will get the same exact scenario as last year. That's not as disastrous as it may seem given that I think the large bulk of the first week of sales probably happen on that first weekend anyways. But that is a risk. We'll cover this issue next.
VI. iPhone 7 Launch Date
Obviously, it's a tailwind if Apple launches the iPhone a week earlier than it did last year and a headwind if it launches the same time as last year. Historically speaking, Apple has lunched the iPhone on the following dates. These dates are when the iPhone started going on sale:
1. iPhone 6S: Friday, September 25, 2015
A. Quarter Ended on September 26, 2015
B. Sale Days: 2
C. Weekend Sales: 13 Million
D. Total Quarterly Sales: 48 million
E. First Weekend Percentage of Total: 27.1%
2. iPhone 6: Friday, September 19, 2014
A. Quarter Ended on September 27, 2014
B. Sale Days: 8
C. Weekend Sales: 10 Million
D. Total Quarterly Sales: 39 million
E. First Weekend Percentage of Total: 25.36%
3. iPhone 5S: Friday, September 20, 2013
A. Quarter Ended on September 28, 2013
B. Sale Days: 9
C. Weekend Sales: 9 Million
D. Total Quarterly Sales: 34 million
E. First Weekend Percentage of Total: 26.63%
4. iPhone 5: Friday, September 21, 2012
A. Quarter Ended on September 29, 2012
B. Sale Days: 9
C. Weekend Sales: 5 Million
D. Total Quarterly Sales: 27 million
E. First Weekend Percentage of Total: 18.52%
I'm to going to go any further back than the iPhone 5 for several reasons. First, the iPhone 4S was launched in October presumably due to health issues with Steve Jobs. It was the first time Apple pushed the upgrade cycle into the fall rather than during the WWDC. Second, it's very helpful in our comparison of the current situation because launching after fiscal Q4 doesn't help us with figuring out what fiscal Q4's guidance will be. Third, the iPhone 4 was launched in June rather than September which makes the sequential comparison to that period moot. Finally, it's obviously better to compare the most recent periods possible as they are more representative of the realities of the current environment.
So with that being said, let's take a look at some of these numbers and compare them to the sequential growth rates. Let's also try and see if we can make a good guess based on this history as to when Apple is lily to begin selling the iPhone 7.
Let's being by making some comparisons among launch years. First, notice how the iPhone 5 only accounted for 18.52% of sales in spite of the fact that the iPhone 5 went on sale a full 9-days ahead of the close of the quarter? Well the reason for that is quite simple really. The iPhone 5 was the most heavily supply constrained iPhone Apple has recently launched. Obviously, the iPhone one and iPhone 3g and 3gs were heavily constrained. But of the more modern era, the iPhone 5 was the most constrained. That was the talk of the entire quarter. Apple's stock actually topped the day Apple started selling the device. So it's not a very good comparison. It at least explains the mere 2.7% sequential rise in sales. And to further support that conclusion, one need only to look at the record sales of the iPhone 5S. Apple nearly doubled the first weekend of sales of the iPhone 5 on launch of the iPhone 5S. That's very significant considering the phones were basically the same. If the iPhone 5 weren't supply constrained, we wouldn't have seen such a dramatic jump on the first weekend of sales from 5 million for the iPhone 5 to 9 million for the iPhone 5S.
Thus, I believe fiscal Q4 2012 isn't a very strong measure of the 'real' sequential growth rate for Apple. Yet, I do think the iPhone 5S is a good representation to a degree. It's a good representation in that the iPhone was launched a full 9-days ahead of the end of the quarter leading to a strong outing off 9 million sales. Don't underestimate just how strong that number is. Apple only sold 10 million iPhone 6's at launch which was a mere 1 million more than the iPhone 5S.
On the other hand, I think the iPhone 5S falls short as being representative of what the sequential growth rate should be given that this is an "s-cycle" phone and given that the smartphone market was still growing very rapidly during that period. It doesn't consider upgraders and the numbers may have come from market expansion of the entire industry.
Yet, I think the iPhone 6 marks the best representation of sequential growth. And get this. Apple only reduced ipHone channel inventory by $100 million going into fiscal Q4. So that sequential growth rate was without Apple drawing down its fiscal Q3 channel. Meaning if we compared the situation to today, the numbers suggests that Apple could produce upwards of 15% or more on a sequential basis under the right environment. If Apple had reduced channel inventory by $2 billion back then and then refilled that channel in fiscal Q4, the growth rate would have been much larger.
The iPhone 6S, as we've already discussed at length, probably doesn't repent the best quarter for sequential growth given that Apple was only able to sell for 2-days before the close of the quarter. So what all of this tells us is that you cannot really just look at the sequential growth rates between 2012 and 2016 and just assume that we're going to be at 5% or there about. There was always some issue impacting each of these quarter. The iPhone 5 was supply constrained and so that number is nonsense. The iPhone 5S was impressive but it's hard to compare to an 'S' year. The growth rate was 6.10% nonetheless. The iPhone 6 was impressive and didn't even have the advantage of heavily reduced inventory. Revenues grew 12.6% in spite of this.
So now let's turn our attention here to whether we think Apple is actually going to launch the iPhone on September 16. Apple's fiscal Q4 ends uncustomary early this year on September 24. In past years, the quarter ended on September 26, 2015, September 27, 2014, September 28, 2013 and September 29, 2012. The iPhone has been released as early as September 19 and as late as September 21 over the past 5-years.
Now here are some arguments for why Apple may relate the iPhone on September 16 as some independent reports have suggested. Last year, Apple introduced the iPhone 6S during the last few days of the quarters. If Apple hadn't done that, chances are Apple would have reported negative growth for fiscal Q1. If the iPhone 6S were allowed to sell the meat of its demand during the last days of Q4, then it's possible Apple would have fallen short of its expectations. So maybe Apple intentionally padded Q1 sales by releasing the iPhone as close to the end of the quarter as possible. That's an expiation. It worked out for the best for Apple.
The second argument one can make is that if you just simply exclude last year, Apple has announced the iPhone exactly 1-week before the end of the quarter for three yeas running. For 2012, 2013 and 2014, the iPhone was introduces exactly 1-week before the end of the quarter. So maybe last year was the exception and not the rule.
A third argument that can be made here is that Apple's management has the opportunity to end this bear market in the stock by simply offering upbeat guidance on a quarter which would be based on selling the iPhone at a date that gives it the greatest advantage over fiscal Q3 2016 (sequentially) and fiscal Q4 2015 (yoy). That date would be September 16 -- one week ahead of the end of the quarter.
So those are three arguments for why based on the history, we could see a September 16, 2016 launch. Now independently of that, I personally spoke with Evan Blass @evleaks who has built a reputation on publishing only very reliable information about the iPhone. He is currently the best leaker in the industry. He has repeatedly nailed the iPhone and has generally been the first to do it. This past weekend he tweeted that the iPhone would be launched on September 16. Thinking that maybe he just simply ran the same analysis as I have here, I sent him a PM and responded to me. I asked him whether he had 'hard' evidence that iPhone would launch on the 16th or whether he was just speculating based on the same analysis I'm conducting here and he confirmed with me that he had independent hard evidence to conclude that the iPhone will indeed launch on the 16th. His twitter handle is @evleaks if you want to follow him. He has the most up-to-date accurate information on what to expect out of the iPhone and he would be good to follow for 2017 ahead of the iPhone 8 launch.
VII. Guidance v. Results Comparison
First let me say, thanks to subscriber Lovical for putting this together yesterday. Not sure if he's ok with me referencing his name, so I'll leave it private. This is a key section as it really potentially sheds light on the entire issue of Fiscal Q4 guidance. Here's why. As we mentioned in the sections above, there is a sequential growth rate trend that falls somewhere in the range of 5-12%. That's what you can expect to see in terms of a sequential growth rate right? Well if this quarter's revenues come in at say $45 billion -- they probably won't -- but if they did, then 5% above $45 billion is $47.25b. What that means is that we can feel confident that Apple will probably at least report $47.2 billion in fiscal Q4 revenue if not more. Remember, we published a set of different reasons why we thought the sequential growth rate will be stronger this year -- namely the fact that Apple will probably release the iPhone a full 8-9 days ahead of the close of its earnings (where last year it was only 2-days), the fact that we have a significant segment of the subscriber base coming off their 2-year contracts, the fact that we have a new iPhone and the fact that Apple has drawn down its Q3 channel inventory by $2 billion which means that Q3 will appear weaker than usual revenue wise. Meaning, if you back in that channel inventory, then we would have a stronger Q3 which means the 5%+Q3 number would be higher indicating that we'r likely to see a larger sequential growth rate than usual this year. Does that make sense? Let me try to restate that.
If Apple hadn't drawn down its channel inventory by $2 billion, then whatever it reports today in earnings, it would have been that number + $2 billion. So suppose Apple came in at $44 billion, without the drawdown in channel inventory, that revenue number would have been $46 billion. If you add 5% sequential growth to that number, it's $48.3 billion. So you can see that this year we're going to need to add a buffer to the sequential growth rate because of the inventory drawdown. That's the point.
Now here is why looking at Apple's past history of guidance versus actual results is important. That trend might give us a hint at what Apple might report today. If Apple has a tendency to beat its upper guidance, then that bodes well for today. And what we see is that all last year, Apple did indeed beat its upper guidance range. Take a look at the table below which was put together by Lovical:
Now take a look at this chart which gives a very good visual sense of how Apple has tended to really come in at the high end of its guidance until just very very recently. Take a look below. Again, the chart is curtesy of Lovical:
Notice how before fiscal Q1 and Q2, Apple either came in around the high-end of its range or above the high-end. For four quarters running, Apple was delivering numbers that was far above its upper end of the range and the stock was performing well because of it. Now at some point, Apple did repeat that when it gives its guidance range, it really does try to give a real actual range of what it actually expects it will report without being conservative at all.
Yet, that being said, you have to consider the fact that the stock fell 20% between the days leading into Q2 earnings and the few days after. In like 12-sessions, Apple lost 20% of its value. So while trying to take the "volatility out of earnings" it has skyrocketed the volatility in its stock price. Hopefully, they have caught on and figured out that being conservative is better than missing. According to this chart, going all the way back to March 2013, Apple has delivered results that come in-line or above the upper end of its guidance range.
So here are my thoughts on this. For fiscal Q1, Apple gave guidance in the range of $75.50 billion and $77.50 billion. It delivered results of $75.87 billion which was at the low end of the range. The stock reacted poorly. For fiscal Q2, Apple gave guidance in the range of $50-$53 billion and it came in at $50.65. The stock crashed. You have to figure that Apple's management has taken a hard look at how it offers guidance and have adjusted their approach. Like put yourself in their shoes. You gave guidance for two quarters that was overly aggressive. It really was. They completely missed the upper end. They weren't even close to the upper end in either of the past two quarters.
So when you give guidance the third time, you have to be thinking that, "well shit, we just missed for two quarters in a row, maybe we should round down on a few items and come out with just slightly more conservative guidance."
For example, if it were me and I want to deliver guidance that I thought was realistic, but at the same time safe in the sense that we have a real shot of reaching the middle end of the range, I would take what I thought the real range would be and then reduce it just so slightly when delivering that guidance.
You have to figure some sort of thinking on this end is going on at Apple's management after how the stock reacted the last two quarters. I will say this, if Apple doesn't deliver revenue at or above its upper range this quarter, then I will have pretty much lost all confidence that the management team understands these concepts. I will pretty much assume going forward that the management team is simply just too unpredictable to be drawing this type of analysis. Like if they report $41 billion, then they're just straight up imbeciles. Because they could have given us any number they wanted last quarter. The stock was going to be punished either way. So they could have given us $40-$41 or $38-$39. It doesn't matter because the stock took a beating regardless. And if they come in at the low end of the range for a third time in a row, it means they either (1) don't care at all; (2) don't really know what they're doing because they have nearly perfect access to information and still fumble; (3) don't consider the stock price at all in their thinking. It's one thing to not prioritize the stock price and it's another to just completely not even consider it at all in their thinking.
Remember, companies don't even have to offer guidance at all. This entire exercise is 100% about THE STOCK. It has nothing to do with the company. So why have a policy that is detrimental to the stock price. Coming in at the low end of the guidance range is far worse than offering no guidance at all. That way analysts can just do this entire exercise on their own. Apple could simply just give key data points like "we're reducing inventory by $2 billion" and let people draw their own conclusions from there.
Because the reality here is that if Apple delivers $44 billion and offers guidance in the range of $45-$47 billion for next quarter, the stock will really. And given what Apple has guided, this is all very realistic.