China In Focus As Apple Reports Q2 Results

Apple (NASDAQ:AAPL) is expected to publish its Q2 FY’24 results in early May, reporting on a quarter that is likely to see Apple’s iPhone experience  sluggish demand. We expect earnings to stand at $1.52 per share, marginally ahead of consensus estimates. On the other hand, we expect revenues to come in at about $90 billion, marking a decline of about 5% compared to last year and about in line with consensus. So what are some of the trends that are likely to drive Apple’s results for the quarter?

Apple’s iPhone business appears to be facing headwinds in China, one of its largest markets. Per Counterpoint Research, iPhone sales in China declined by 24% over the first six weeks of 2024, compared to the Chinese smartphone market which declined by 7% over the same period. Apple has been resorting to discounts to prop up sales and better compete with the likes of Huawei, who has been gaining ground in the high-end of the market. While this could be partly offset by gains in markets such as India, we expect overall iPhone sales to come under pressure over the quarter. Apple’s Mac business could see a turnaround over the quarter after a tough 2023. IDC estimates that Apple’s Mac shipments expanded by about 14.6% over the quarter to 4.8 million units, outpacing the broader PC market which grew by 1.5% over the same period. Apple’s digital services business should also fare well, driven by higher sales at the AppStore and improving the uptake of other subscription services. Over Q1 FY’24, services sales grew 11.3% to $23.1 billion. Although Apple has seen its gross margins rise in recent years, driven by a favorable sales mix skewed toward premium products, and also due to some cost cuts, there is a possibility that margins could see pressure amid easing iPhone demand and higher costs related to the iPhone 15 models.

AAPL stock has shown strong gains of 25% from levels of $130 in early January 2021 to around $165 now, vs. an increase of about 30% for the S&P 500 over this roughly 3-year period. However, the increase in AAPL stock has been far from consistent. Returns for the stock were 35% in 2021, -26% in 2022, and 49% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that AAPL underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for other heavyweights in the Information Technology sector including MSFT, NVDA, and AVGO, and even for the megacap stars GOOG, TSLA, and AMZN.
In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could AAPL face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

We value Apple at about $183 per share, which is about 10% ahead of the current market price. Although growth is likely to remain muted this year, we think that Apple should see an upside from selling more premium products and a greater mix of services. Apple also has a big opportunity in the generative AI space. Although Apple has avoided making big announcements on the AI front over the past year, unlike rivals such as Microsoft and Facebook, following the success of ChatGPT and similar tools we believe Apple could be a big winner in this space for a couple of reasons. Unlike most companies that use public data, large language models, and high-power GPUs, Apple has a unique position in terms of implementing AI on-device, while keeping user data private. The company has the best in class mobile processors which could give it an advantage in more personalized, end-point AI applications.   See our analysis of Apple’s Valuation for more details on what’s driving our price estimate for Apple and how it compares with peers.

[1] Returns as of 4/20/2024
[2] Cumulative total returns since the end of 2016

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