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With Apple's Shares at an All-Time High, Its Earnings Report Needs to Clear a Higher Bar


By Eric Jhonsa ,The Street

Apple (AAPL)  shares closed at a new all-time high yet again on Monday, and are up more than 21% since putting out a better-than-expected fiscal first quarter (December quarter) report on January 31. Shares still aren't all that expensive -- they trade for 14 times a fiscal 2018 (ends in September 2018) EPS consensus of $10.28, and that's before accounting for the roughly $160 billion in net cash the company has -- but it's safe to say that expectations have risen.

A lot of those expectations, of course, revolve around a much-anticipated September iPhone 8 launch rather than how Apple performed in the March quarter or how it expects to fare in the June quarter. Still, a higher bar could cause some post-earnings profit-taking, if it turns out that a few recent trends are having a meaningful impact on iPhone sales and profits.

[post_ads]On average, analysts polled by FactSet expect Apple to announce fiscal second quarter revenue of $53.06 billion (up 5% annually) and EPS of $2.02 (up 6%) when its reports at 4:30 PM ET on Tuesday afternoon (TheStreet will be covering Apple's earnings via a live blog; please check our home page tomorrow for more details). The consensus for third quarter revenue, which Apple should provide guidance for in its earnings report, is at $45.6 billion (up 8%).

iPhone sales are expected to be up 4% to $34.3 billion (65% of total revenue). And for now, they're forecast to rise 10% in the June quarter to $26.5 billion. Unit sales of 67 million are expected for the March quarter, and 58 million for the seasonally weak June quarter. Stronger-than-expected fiscal Q1 iPhone shipment and average selling price (ASP) prints, along with weak early-2016 sales, have markets optimistic that positive iPhone sales growth can be posted ahead of the iPhone 8 launch.

But there are some near-term pressures to keep in mind, perhaps the largest of which is depressed smartphone upgrade activity. Verizon (VZ) and AT&T (T) each reported lower smartphone sales, as consumers continue adjusting to paying the full price of a phone (or close to it) via installment plans rather than getting heavily-subsidized hardware.

Verizon's wireless equipment revenue fell 4.8% to $3.8 billion in calendar Q1, and its retail postpaid device activations fell by 8% to 9.1 million. AT&T's wireless equipment revenue fell 17% to $2.6 billion, and its postpaid phone upgrade rate fell to 3.9% from 5%. On AT&T's earnings call, CFO John Stephens declared phone upgrade rates "are hitting record lows," and though he admitted rates will likely bounce due to the iPhone 8 and Samsung Galaxy S8 launches, he also argued lower upgrade activity represents "a permanent change from where we were in the subsidy model."

The strong reception seen for the Galaxy S8 -- Samsung says pre-orders for the phone, which officially went on sale on April 21, were up 30% relative to Galaxy S7 pre-orders -- could also be a headwind. But high iPhone/iOS ecosystem loyalty rates should limit the damage. Likely a larger issue: Many iPhone owners are bound to delay upgrading due to the hype surrounding the iPhone 8. 

With the iPhone 8 expected to feature a curved OLED display, wireless charging support, an all-glass design and a front camera with 3D sensing abilities, consume enthusiasm is clearly stronger than it was for the iPhone 7, whose pre-launch headlines were often related to Apple's plans to ditch the traditional headphone jack.

Chinese iPhone sales also bear watching. Apple's mainland China revenue was flat in fiscal Q1, albeit up 6% in constant currency. After accounting for double-digit Chinese MacBook and iPad shipment growth, and estimated 100%-plus Chinese App Store revenue growth, iPhone sales may have been lower even on a currency-adjusted basis. Research firm IDC estimates Chinese iPhone shipments fell 12.8% in calendar Q4 to 14.9 million amid intensifying competition from local Android OEMs.
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And looking at Apple's bottom line, surging DRAM and NAND flash memory prices could impact the company's gross margin across its hardware lineup. The fact that Apple doubled storage capacities across iPhone price tiers with the iPhone 7 launch adds to its NAND exposure. The company guided in January for a March quarter gross margin of 38% to 39%, down slightly from a year-ago level of 39.4%.

On the bright side, strong demand for the iPhone 7-Plus ($769 starting price) and its dual-lens rear camera could make ASP expectations look conservative. With the iPhone 7/7-Plus expected to decline as a percentage of total iPhone sales, analysts on average only forecast a March quarter iPhone ASP of $658 -- up by $16 annually but down by $37 sequentially. And ASP is forecast to drop to $621 in the June quarter, before rising in the following two quarters as the iPhone 8 launches.
And it's worth keeping in mind that iPhone sales were pretty weak a year ago due to low iPhone 6S upgrade activity: iPhone unit sales fell 16% in the March quarter last year, and 15% in the June quarter. That makes it much less difficult to deliver positive growth.

Weak year-ago sales are also expected to help Apple's Mac sales rise. With a healthy reception for last fall's MacBook Pro refresh providing a tailwind, Mac revenue is forecast to grow 8% to $5.5 billion. iPad revenue, on the other hand, is expected to remain pressured, with revenue expected to drop 12% to $3.9 billion and unit sales totaling a modest 9 million. "Other Product" revenue, which covers the Apple Watch, Beats headphones, AirPods, Apple TV set-tops, iPods and accessories, is expected to rise 3% to $2.3 billion.

Apple's burgeoning Services business is expected to see revenue grow 18% to $7.1 billion, aided by the App Store and Apple Music's momentum along with double-digit growth for Apple's installed user base. In January, Tim Cook said Apple aims to double its Services revenue by 2020, a comment that fueled speculation that a major services-related acquisition will happen in time.

Markets are well-aware that Apple is entering a seasonally weak period for its biggest business. And the amount of hype surrounding the iPhone 8 could make some investors quick to forgive a light June quarter sales outlook. But the big gains Apple has seen over the last few months could make a post-earnings selloff on account of short-term revenue pressures easier to come by.

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