Apple (AAPL) revealed last night its highly awaited quarterly earnings report, delivering a top- and bottom-line beat and what some view as a guidance letdown.
Leading the numbers higher were the iPhone (49% of revenue) and Services (26% of revenue) businesses. But Apple’s guidance for the current quarter that calls for low-to-mid single-digit revenue growth, which fell short of the market expectations of around 7%. Complicating the matter, Apple declined to spell out how its various businesses align to support its revenue outlook other than to say it sees its higher margin services business growing double-digits and targeted gross margins are 46%-47%.
The Logic of Cautious Guidance
When asked repeatedly on the earnings call about iPhone prospects for the current quarter, management did not offer any additional color. But if we model out its guidance, it implies its Product revenue as flat or up modestly in the December-ending quarter. Looking through earnings call comments about the recent iOS 18.1 software release, which includes initial Apple Intelligence features, it’s clear management is taking a cautious view of what it means for the iPhone upgrade cycle. We believe this is because of the timing for the next iOS update 18.2, which will have more robust Apple Intelligence features, including ChatGPT integration. It’s that software update, targeted for late November and early December release, that could bring a more pronounced upgrade to iPhone 15 and iPhone 16 models. Given that, we’re not surprised by Apple's cautious and somewhat cryptic guidance.
Services: The High Margin Sleeper
The positive is the continued growth in the Services business, which sports gross margins of 74% or so, far above the 35%-37% for the Products business. And while some will dote on the Service business hitting a $25 billion quarterly run rate, we’d rather focus on its recurring nature and that it accounts for more than 40% of Apple’s overall gross profit dollars. Recognizing mix shifts in a company’s revenue and gross profit stream, whether it's Axon (AXON) , Amazon (AMZN) , or Apple (AAPL) , is key to understanding how it generates its bottom line. In the case of Apple, the continued growth in the Services business, led by Product sales and new Service offerings helps reduce Apple’s sales reliance on iPhone but also means more steady profit and EPS generation.
Waiting for iOS 18.2, More of Apple Intelligence
Getting back to iPhone, because it remains Apple’s largest revenue generator (48% of year-to-date revenue), we can expect the market to focus on how it could ramp up in the coming months but also in 2025. In our view, given the timing of iOS 18.2, the highly anticipated upgrade cycle touted by many on Wall Street is more of a 2025 story than one for this year. With more Apple Intelligence features targeted for not only iPhone but also Apple’s other product categories (25% of sales) including Mac, iPad, and Wearables, we see a similar cadence unfolding for them as well as other software updates are released. As that happens, we should see further lift in the Services business, driving overall profits and EPS higher.
The long and short of it is that Apple’s earnings last night haven’t changed our thinking about the company in the near term or longer. Apple still needs to deliver must-want features with Apple Intelligence and the proof will begin with iOS 18.2. While we think Apple will be successful, we will look for confirming data points, especially once that software update is released. Should they come, and beta testing of the release suggests they will, we are likely to see more enthusiasm for new iPhone models and Apple shares.
Near-term, however, we are likely to see Apple’s cautious guidance lead to some price target revisions lower, especially among the more aggressive ones near or above $300. We will stick with our $250 price target and revisit it as warranted following the release of iOS 18.2.
Because the portfolio’s AAPL position is sizable at around 3.8%, we previously stated we would be interested in picking the shares up closer to $200, should they find their way there. Until we see signs of an accelerating upgrade cycle, that remains our plan.
Other upcoming catalysts we’ll be watching include quarterly results and guidance from Qualcomm (QCOM) and Skyworks (SWKS), Taiwan Semi’s (TSM) October revenue report, and investor conference comments in November and early December from the likes of Verizon (VZ) and AT&T (T).
