Trade war and iPhone sales: What to watch for in Apple earnings (AAPL)

Tim Cook Sun Valley

Apple reports its June quarter earnings on Tuesday.
Apple's 3rd fiscal quarter is its slowest both in terms of revenue and iPhone sales.
But there are still a lot of important details and hints about the future that investors and analysts will be watching closely.

Apple has a chance to give investors another reason to keep Apple's bullish streak going when it reports earnings after markets close on Tuesday. Apple shares are up 15% in the past three months, buoyed by a massive capital return program announced in April.

In its fiscal 3rd quarter earnings, which cover the three months ending in June, Apple will reveal whether the iPhones it launched last September are enjoying sustained demand, or whether the more expensive $1,000 iPhone X fizzled in the slow season after last year's all-important holiday quarter. Generally, Apple's spring quarter is its slowest both in terms of revenue and iPhone sales.

"Our checks suggest demand for iPhone 8 and 8 Plus remain seasonal while iPhone X inventory has normalized and older models continue to do well in emerging markets," Citi analyst Jim Suva wrote earlier this month.

Wall Street is looking for Apple to report revenue of $52.3 billion, up 15% year-over-year, and earnings per share of $2.16.

But investors will also keep a close eye on commentary and details buried in the report that might suggest where Apple is going, especially this fall, when it's expected to launch new iPhones.

Here's what Wall Street is looking for:

iPhone sales

Given that the iPhone makes up the majority of Apple's revenue, it's only logical that investors would want to know how many iPhones were shipped and the average price they were sold for.

Even a small difference in that number can change Apple's earnings from a good day to a bad day for the stock.

Morgan Stanley's Katy Huberty, for example, is expecting Apple to say that it shipped 39.8 million iPhones in the June quarter, underneath the consensus estimate for about 41.8 million iPhones shipped.

Apple store

Services

But increasingly, investors are looking at Apple's services — the money it makes selling subscriptions to people who own iPhones — as the primary driver of what could make Apple a more valuable company than it already is.

"Given iPhone results matter less late in a cycle ... we expect investors to focus increasingly on Services results as a sign of whether Apple's installed base monetization efforts can drive overall company growth despite declining device revenue," Huberty wrote in a July 23 note.

Apple defines services as revenue it gets from iCloud, Apple Music, App Store, iTunes, and AppleCare, and sometimes Apple comments on its growth, especially during slower quarters.

"Services is an increasingly important piece of the AAPL story and a major driver of gross margins," RBC analyst Amit Daryanani wrote in a recent note. "The segment currently accounts for ~15% of revenues and is on track to become a ~$50B business by 2020."

Huberty is looking for Services to grow 32% year-over-year, which would be a big jump.

China

Tim Cook China The Chinese market remains the area where Apple could see the greatest growth, given the country's growing middle class.

But Apple also faces intense competition from domestic makers of Android phones, as well as regulatory issues in the middle kingdom. So far, Cook and his managing director of China, Isabel Ge Mahe, have managed to successfully navigate the tricky regulatory landscape.

"China production data (int’l down 29% in F3Q) implies Apple’s Greater China sales growth will slow from 21% in F2Q," Nomura's Jeffery Kvaal wrote.

The upcoming cycle

Often guidance for Apple's fiscal 4th quarter will include a little bit of sales from Apple's newest phones, which are typically announced in September and go on sale shortly afterward.

However, one week of sales isn't usually enough to know whether the new product cycle is going to be a hit or not. That hasn't stopped analysts from speculating that if Apple's guidance is strong, it could be a hint that the company expects a big iPhone launch.

"While all eyes will be on Apple's will FQ4 guidance, we note that historically, revenue guidance for FY Q4 has *not* been a helpful predictor of the strength of the forthcoming cycle," Bernstein analyst Toni Sacconaghi wrote.

Apple's passion projects

Apple is working on several new technologies that could unlock huge new markets: self-driving cars, augmented reality, and health and medicine.

All of these "special projects" and "technology investigations" are secretive. But sometimes, Apple officials during an earning call provide commentary that suggest that they see them as big projects and can guide expectations for increased revenue in the future.

"In our opinion, revenue contribution can be significant even without Apple introducing any dedicated AR hardware," Bank of America Merrill Lynch analyst Wamsi Mohan wrote in a note. "Specifically, we estimate that AR can add $1 billion revenue by end of fiscal 2020 from App Store downloads alone."

If Apple's data privacy policies are showing up on the bottom line

Apple has made data privacy a key marketing and engineering priority for the company, and it started to pay off earlier this year when Facebook came under fire for allowing companies like Cambridge Analytica to access people's data.

CEO Tim Cook even took a few barely veiled shots at Facebook.

So some analysts, like D.A. Davidston analyst Tom Forte, are looking for "comments by management on the importance of data privacy and its efforts to address that in the updated versions of its operating systems."

The trade war

Tim Cook Donald Trump Reuters reported earlier this month that Apple's Apple Watch may be affected by tariffs proposed by the Trump administration.

This could lead to an increase in the price of the Watch or a decrease in Apple's margins.

Analysts will be watching to see if Apple leadership provides any commentary on how the simmering trade war could affect any Apple products.

"If there were any incremental tariffs invoked, we believe Apple would pass that cost to consumers and our view is any price increase is not a positive for demand," Citi's Suva wrote.

"We also note iPhone is not in the July 2018 tariff list for 818 goods," he continued.

How Siri fits into the company

Earlier this month, Apple announced that it had consolidated its Siri department under one head: John Giannandrea, which the iPhone giant hired away from Google earlier this year.

This could signal a bigger emphasis on Siri and artificial intelligence in general at the company.

Commentary from Cook or CFO Luca Maestri could clarify the reasoning and hopes for the personnel change.

"While we still see Apple playing catch up with Amazon’s Alexa and Google’s digital assistant, we are encouraged by the April 2018 addition of John Giannandrea (Google’s former chief of search and AI) to bolster Siri," Forte, the Davidson analyst, wrote.

Any sign people are hanging onto their iPhones longer

One bear case for Apple is that people replace their iPhones less often as the technology gets more mature. The closer replacement rates edge to three years instead of two years, the stronger the case gets.

"iPhone replacement rates have normalized over the past few years in the 2.5-year range after being as low as 2.2 years on the iPhone 6 cycle," BMO Capital Markets analyst Tim Long wrote. "We believe there could be further lengthening if the new product cycle is not compelling."

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