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Apple Inc. (NASDAQ:AAPL) Shouldn’t Count on China for Growth: Cowen

Tim_Cook Apple Inc music

Apple Inc. disappointed the world on Tuesday night. The firm’s earnings came in solidly above what was forecast on Wall Street, but guidance for the months ahead was marred by a negative feeling about the fourth quarter. It seems that China may be failing, but Apple investors are the first to hear about it.

Tim_Cook Apple Inc music

Apple sells more stuff than almost anyone else in China, giving the firm an insight into the economy of the country that nobody else has. Cowen & Co. analyst Tim Arcuri noted, in a report issued late on Tuesday July 21, that demand in China is likely to be a weight on the firm in the months ahead. That could mean that Chinese people no longer love the iPhone, or it might mean that they’re buying less overall.

Falling out of love with the iPhone 6

Apple  shares fell by more than 8 percent on Tuesday’s after-market before bouncing back. At time of writing, three hours before the market is set to open in New York, shares in the firm are trading at $123.20 , down 5.77 percent from yesterday’s closing price.

Mr. Arcuri says that though services and other segments are growing, “iPhone units remain the key driver for the stock.” He reduced his price target on shares from $140 to $130, and lowered hit rating on Apple shares from Outperform to Market Perform. Arcuri says that a trend in earnings is clear. Evidence of a widespread demand reset from China is mounting, he says, though Apple’s CEO doesn’t agree.

Tim Cook said that he wasn’t worried about problems in China on yesterday’s conference call. “We remain extremely bullish on China and we’re continuing to invest,” he told those on the call, “Nothing that’s happened has changed our fundamental view that China will be Apple’s largest market at some point in the future.”

Apple revenue in China grew from $6.23bn in the June quarter of last year to 13.23 billion in yesterday’s report. Apple is guiding for Revenue of slightly higher in the fourth quarter, and most of that growth will be expected to come from China.

Mr. Arcuri is worried that the growth spurt in China, will slow taking Apple’s last major growth market away. In the second quarter of last year Apple brought in $39.8bn compared to $49.43bn this time around. China was responsible for $7bn of that growth, an amazing 72 percent of the entire sales increase during the quarter.

iPhone is the only growth at Apple

The iPhone 6 is responsible for almost all of that growth, of course. Apple still relies on the smart phone for the vast majority of its sales. The firm missed Wall Street’s forecast for sales of the device in the quarter, selling 47.5m units against a Wall Street forecast of 49m.

64 percent, or $31.37B, of the firm’s sales came from the iPhone. In the same three months of 2014 Apple made $19.8 billion from the iPhone. That means that iPhone growth accounted for close to 120 percent of total growth in the quarter.

The shortfall is met by the falling sales in the firm’s iPad business. What was once set to be the next iPhone in terms of sales is now a product that most of those with shares in the firm appear to want to ignore. Apple sold 10.1m iPads during the period, down 18 percent on sales in the same three months of last year.

Mr. Arcuri reckons that Apple will be able to spur growth in some of its segments in order to bring growth from realms outside of the iPhone, but that’s not going to happen any time soon. Growth is from the iPhone, and growth in the iPhone is from China.

That’s what traders appear to be taking from Tuesday’s earnings. Neither part of that growth is going to be able to keep up for very long.

Apple outlook is weak

Apple says that it expects to earn between $49B and $50B in the current quarter. The Wall Street consensus estimate was looking for sales of more than $51B. The outlook means one of two things. Either Apple doesn’t expect to launch a new iPhone before the end of the quarter, or the firm doesn’t expect sales of the new smart phone to be all that strong.

Wall Street is taking the latter idea to heart on Wednesday. In the run up to the release of Tuesday’s earnings there was a lot of talk about the slow down in iPhone sales that Apple is likely to see once the strong iPhone 6 cycle is over. With more than 100 percent of the firm’s sales growth coming from the iPhone, that’s going to hurt the firm.

Apple’s Tim Cook and Luca Maestri appeared to confirm that idea on Tuesday. Their outlook is weak. If that reflects their forecast for sales of the next iPhone, it means that the whole of next year are liked to come in below the hopes of Wall Street.

Apple sales in the fourth quarter of 2014 came in at $39bn and while the $49bn that the firm expects to bring in amounts to a rise of around 25 percent, it also represents the last quarter of iPhone 6 sales. Moving on from there is going to be hard.

Finding hope in Apple earnings

Gene Munster of Piper Jaffray, in a report published on Wednesday July 22, said that he thinks that Apple looks stronger after the firm’s second quarter earnings. He raised his price target on the firm from $162 to $172 and said that margins next year will make investors happier.

Apple is usually able to boost margins with the S iteration of its main smartphones. Margins in the months through June came in at 39.5 percent, slightly below the 39.9 percent recorded in the March quarter. Mr. Munster reckons that these numbers will inch higher next year, giving investors something to grasp onto as earnings growth outpaces sales growth.

Mr. Munster’s forecast of outsized earnings growth on the back of higher margins could be disputed because of the cost of the Force Touch tech that Apple is going to put in the next iPhone. It’s not clear how much the parts are going to cost, but margin growth may not be as solid this time around as it was in past iPhone S releases.

Andy Hargreaves of Pacific Crest looked for a silver lining where he could, but settled for limiting the negatives in  report published on Wednesday morning. “The stickiness of the iPhone user base should prevent material downside,” he wrote, though “the stock may lack nearterm catalysts.”

Many other Wall Street voices are going to speak out on Apple this time around, but the tone of the reports has already been made clear. Apple is going to face headwinds because it’s not going to grow iPhone sales in the next year.

Wall Street is going to take a watch and wait approach for the most part. With sales of the Apple Watch disappointing, there’s no clear path for the firm to grow its sales in the year ahead. Until Tim Cook shows off something that might change that, there’s going to be a lull in sentiment.

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