Revisiting Apple's iPhone Woes As Stock Dips Into Bear Market Territory

Apple Inc. AAPL's stock has entered bear market territory, with the performance of its newest iPhone models largely to blame. 

The stock has pulled back by about 20 percent from an Oct. 3 intraday high of $233.47. 

Apple shares have underperformed since October, having shed about 17 percent on a closing basis compared to more modest declines of 7.3 percent in the S&P 500 Index and 11.3 percent in the Nasdaq Composite Index.

Although some of the weakness could be traced back to a market-wide sell-off triggered by macroeconomic, monetary policy and geopolitical concerns, much of it has to do with sagging iPhone volumes.

The Ailing iPhone 

Ever since Apple launched its latest iterations of iPhones —the XS, XS Max and XR — it has been scaling back production estimates.

Over the past week alone, the company scaled back estimates by 6-7 million from the original 63-million build target for the new  models, UBS analyst Timothy Arcuri said in a Wednesday note.

The cut is evenly split between the XS Max and XR models, he said. 

Longbow Research analyst Shawn Harrison said in a note released earlier this week iPhone orders are down 20-23 percent year-over-year. Another factor portending to further weakness ahead is the sharp drop in Baidu October iPhone searches in China, arguably the biggest market for the smartphone, the analyst said.

UBS estimates calendar Q4 iPhone sell-in to retailers of 73.5 million, down from the previous estimate of 75 million. The sell-through is expected to drop 3 percent year-over-year, assuming a 2-million channel build. UBS lowered its ASP estimate from $832 to $825.

UBS also lowered its estimates for Q1 and Q2 of 2019 to suggest 11-percent and 9-percent year-over-year declines, respectively. UBS sees inventory negatively affecting the supply chain.

"Ultimately, we believe AAPL continues to face FX headwinds given ongoing USD appreciation against key global currencies." 

UBS maintained a Buy rating on Apple and lowered the price target from $240 to $225.

As recently as Tuesday, a Goldman Sachs analyst forecast a 6-percent year-over-year decline in iPhone production in 2019, according to CNBC.

Supplier Weakness Points To Tough Days Ahead

The Street has been awash with news about setbacks at Apple suppliers throughout the Q3 reporting season.

Rosenblatt Securities analyst Jun Zhang attributes the weakness in iPhones to issues at Skyworks Solutions Inc SWKS. This may prompt Apple to lower XR production by an incremental 4-5 million units in Q4, the analyst said. 

Skyworks recently warned of year-over-year declines in revenue and EPS in Q4, citing industrywide headwinds.

Lumentum Holdings Inc LITE, a supplier of 3D chips used in iPhone's facial recognition system, downwardly revised its fiscal Q2 guidance, attributing the predicament to "a request from one of our largest industrial and consumer customers."

Qorvo Inc QRVO also joined the party, cutting its Q4 revenue guidance on the basis of lower orders for radio frequency chips from its leading customer.

Canaccord Genuity analyst Michael Walkey reiterated a Buy rating on Qorvo and reduced the price target from $90 to $83, banking on Qorvo's strong positioning in the non-handset-related RFIC portfolio directed at higher-margin defens, aerospace and network infrastructure markets. 

See also: Time For Apple's Stock To Enter A 'Period Of Digestion,' Guggenheim Says

A Panacea In Services?

Apple is transitioning from a product-focused company that primarily manufactures and sells devices to a model of "maintaining and satisfying a large and growing customer base with ever-improving hardware and an increasing portfolio of software services," said Loup Ventures' Gene Munster.

This rationale was behind Apple's decision to stop reporting hardware unit numbers, he said in a blog post. 

Underlying business performance has not historically been correlated to unit sales, and a unit of sale is less relevant today than in the past due to the wide price dispersion within the iPhone product portfolio, Munster said. 

"This is important because each unit of sale can now have a very different impact on revenue." 

An analysis of Google Trends search data shows that interest is not confined to new Phones alone, but is evenly distributed among the older and newer models, Munster said. 

Sell-side analysts see Apple's Services business gaining traction.

Jefferies analyst Timothy O'Shea said the Services business could account for 25 percent of all revenue, at $80-billion-plus, and for 40 percent of total gross profit by 2022.

Apple could continue its stellar performance, as higher ASP is still expected to cushion much of the weakness in volume, and the Services business and remainder of the product lineup, including the Watch, emerge as major contributors, he said. 

Guggenheim Partners analyst Robert Chira recently downgraded Apple shares from Buy to Neutral, reasoning that the shares are entering a period of "digestion" after a strong run in recent years. 

Related Link: Reading Between The Lines Of Apple's Decision To Go Silent On iPhone Unit Sales

Photo courtesy of Apple.