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Apple Inc. (AAPL) Earnings: Investors Should Blur iPhone 7 Focus

Apple inc. (NASDAQ:AAPL)

Apple Inc. earnings are going to hit Wall Street this afternoon. Like any big announcement from the firm, it’s going to attract outsized attention. This time around traders will once again look to iPhone sales to drive the firm’s growth, but it might be time to change that tack. There’s a growing feeling on Wall Street that the iPhone 6 is “the big one” and that growth in the segment is slowing.

Apple inc. macbook-air-12-inch-retina

A stock is priced by traders based on forecasts its earnings power in the future. It’s that cash flow that gives the firm value, and Apple is no exception. The firm’s shares are trading at 14 times forecast 2015 earnings on Tuesday, July 21. That means there’s likely earnings growth priced in, but nobody knows where it’s coming from.

Giving away the iPhone

Macquarie analyst Ben Schachter weighed in on that topic with a report published on Tuesday ahead of the Apple earnings reveal. Mr. Schachter said that he is “concerned that the growth simply won’t be there” when Apple reveals the iPhone 7 later on this year.

The iPhone is the most sought after device in consumer electronics, and Apple knows it. Phil Schiller’s marketing team has put the ubiquity of the iPhone at the center of a new ad campaign.

Schachter thinks that the “focus for investors” will have to switch to other segments at Apple  in order to keep the mood around the firm’s growth stable. The focus of the team at Apple will also have to change.

Even if iPhone sales are set to slow, the firm will want to keep growing the business bit by bit in the coming years. For now it seems that slowing growth is going to be impossible to avoid.

Wall Street’s forecasts, most of which assume a rise in the price of the stock over the next year, aren’t looking for huge gains at Apple after the iPhone 7 is released.

Apple growth will slow down

Revenue forecasts on Wall Street are strong for 2015, but 2016 will not see the same kind of gains, simply because the release of the iPhone 7 is not set to equal that of the iPhone 6. Wall Street is looking for sales of $232bn from Apple for the full year 2015, and $246bn in 2015. That’s sales growth of just 6 percent, a sorry level for Cupertino.

Earnings are set to see the same kind of slow down. Wall Street is looking for earnings of $9.08 per share for the fiscal year 2015, and earnings of $9.77 per share for 2016.

That’s growth of just 7.5 percent, a small number for traders used to massive rises in earnings due to the iPhone 6. Apple  EPS will grow by more than 40 percent from 2014-2015 if Wall Street’s numbers are right.

Apple growth is slowing. Just as the massive rise in the firm’s earnings were driven by the iPhone, the slow down will be driven by the same. Apple is a “cash-flow machine” in the words of Jim Suva from Citigroup, but the price targets on Wall Street price in a huge amount of growth.

Apple looks at the Mac

Apple isn’t just growing in smartphones, though that may be where most of the firm’s money comes from. In the years ahead Macquarie’s Ben Schachter says that the firm’s other businesses will “become more of a focus for investors.”

In the second quarter as sales of the PC fell sales of the Mac boomed. That rise was driven by the release of the new MacBook and the traditional strength of Apple’s PC business. The IDC’s look at the global PC market in the three months through June forecasts sales of 5.136m Macs.

Apple sold just 4.4m Macs in the same three months of last year. That means that sales growth in the Mac segment hit close to 16 percent if the numbers hold up when Apple’s report appears later on today.

Mac sales haven’t flown over the last few years, but they’ve stayed stable in a shrinking market. If Apple keeps putting effort into the segment, something it clearly did with the bold design of the 12 inch MacBook, the firm may be able to grow that business.

Mac is a perfect example of an overlooked business that is driving strong sales at Apple. There’s many more segments that have shown strong growth that has gone masked by the amazing trend in iPhone sales.

Building a world around the iPhone

The best ad for the Mac is an ad for the iPhone. Sales of the PCs have likely grown because of the halo-effect. People who own one Apple product are much more likely to buy another. Now that almost everybody owns an iPhone, Apple can lever that weight to drive sales of other products.

Apple did that in a very explicit way with the Apple Watch. There’s no point in owning the device if you don’t have an iPhone. We’re unlikely to see sales figures for that device, and a judgement of how that strategy worked, in this afternoon’s earnings report, but Tim Cook might surprise.

Brian White of Cantor Fitzgerald has a monstrous $195 price target on Apple stock. He bases that idea on the “digital matrix” of “Planet Apple.” He reckons the next leg of growth at Apple   will be driven by software and services. Apple Pay, Apple Music and Apple will all be major contributors to the bottom line according to White.

Mr. Schachter of Macquarie follows the same line, but focuses on the App store. In his view the App store may be the jewel in Apple’s crown. It’s “widely underappreciated” according to Mr Schachter, and it’s going to be a big addition to the firm’s bottom line in the years ahead.

Trip Chowdhry of Global Equities Research says that the Apple Watch will have solved most of Apple’s growth problems by the end of 2015. He reckons the firm will sell around 40m units of the device in the coming year. At an ASP of $500, that brings sales up by $8bn or a 3 percent sales bump year over year.

Putting an unfocused iPhone at the center

Those with shares in Apple aren’t going to be able to look at the iPhone for growth for much longer, but they won’t be able to take their eyes off of it either. Looking at Apple from 2015 on is going to be different.

The firm’s business will no longer grow in one segment, in the future investors will need to see a broad base of growth. Even if Apple sold 5m Macs in the quarter, the sales implications are nothing like the iPhone. Growth across the firm will be needed to justify the price targets set on Wall Street.

The Mac isn’t going to save Apple, but it shows off the power of the iPhone, and Apple, brand in a clearer way than any other business at the firm. As PC sales collapsed, Mac sales stayed steady and rose. The core appeal of that PC is in the pocket of the user.

Just because iPhone sales aren’t going to grow doesn’t mean the device has nothing to add to the bottom line. For years to come, even if sales never break 250m units, the device is going to be the center of Apple’s world, its earnings backbone, and a platform to push sales in other segments higher.

Traders are going to have to replace its position in their idea of the firm, but Luca Maestri and Tim Cook are likely to help them along in the way they structure earnings.

 

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