Apple Q1 Earnings Preview: Investors Brace For Update On Turbulent Quarter Marred By iPhone Weakness

Apple Inc. AAPL is going through a tough phase given the issues surrounding its flagship product, the iPhone. From an intraday high of $233.47 hit Oct. 2, Apple stock ended the calendar fourth quarter at $157.74, a drop of about 33 percent.

Given the muted offtake of its latest iPhone iterations, Apple was forced to scale down shipment forecasts and even its broader guidance.

Will the fiscal first-quarter results due after the close Tuesday, Jan. 29 help Apple redeem itself?

Key Numbers

Analysts, on average, expect Apple to report EPS of $4.17 compared to $3.89 one year ago. The estimate has been lowered from the $4.95 forecast 90 days ago.

Revenues are expected at $84.04 billion, down 4.8 percent year-over-year.

Apple guided Q1 revenue to a range of $89 billion to $93 billion and gross margins to 38-38.5 percent Nov. 1 when it released its Q4 report. Subsequently, the guidance was lowered in a letter from CEO Tim Cook to shareholders made public Jan. 2, with the revised expectations calling for revenues of about $84 billion and a gross margin of about 38 percent.

Despite headwinds such as weakness in China and delayed upgrades due to higher ASPs and a generous battery replacement program, Apple will report a record EPS for the quarter, partly helped by decreased share count, according to Loup Ventures' Gene Munster.

Change In Reporting Methodology

At the time of its Q4 release, Apple announced its decision to embrace a new reporting methodology.

The Cupertino, California-based tech giant decided to refrain from breaking down unit shipments of individual products, which incidentally spooked the market.

The company also said it will give margin breakouts for the services and products segments. 

With Apple's decision to reclassify revenues across hardware and services categories, the company will be adding $2.56 billion to services revenues to reflect the deferred value of Maps, Siri and free iCloud services, which were previously bundled with product sales, RBC Capital Markets analyst Amit Daryanani said in a recent note.

This will reduce revenue across the hardware categories by an equivalent amount, the analyst said.

Munster said Loup Ventures backs Apple's change in reporting and said it follows "a strategic shift in their business to a more service-based model."

Munster expects services to post a 65-percent gross margin and account for 13 percent of revenue, and for products to show a 27-percent gross margin and account for 87 percent of revenue. 

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

The iPhone: Cash Cow Turned Achilles' Heel?

Apple introduced three iPhones late last year: the iPhone XS and iPhone XS Max, both of which went on sale in late September, and the iPhone XR, a budget model phone that began shipping in late October.

Ever since the releases, these products have been hit by negative headlines concerning demand. Demand in China has been faltering, with the trade tensions between China and the U.S. serving as one of the contributing factors.

Apple's iPhone woes have come to haunt its suppliers, and many were forced to lower their guidance in response to the tempered demand.

Demand for both the iPhone XR and XS/Max has been increasingly disappointing, which in turn has led to higher inventories, KeyBanc Capital Markets analyst John Vinh said in a recent note.

"This could be one of the most disappointing cycles since the iPhone 6s," he said. 

Loup Venture's Munster estimates a 17-percent year-over-year decline in iPhone shipments, making it the worst iPhone year-over-year unit growth to date. 

Bank of America Merrill Lynch analyst Wamsi Mohan forecasts iPhone unit shipments of 65 million for the December quarter and 41 million for the March quarter.

Investor Focus

The following are key areas investors are likely to focus on, according to analysts:

• Commentary on product versus services margins, and trajectory for services margin.
• Commentary on services revenue growth.
• Use of cash for buybacks vs. R&D and M&A.
• Details on timing and scope of video content.
• Apple's interest in the health care sector.
• How the Chinese market is faring entering the March quarter.
• Demand in other emerging markets.
• Changes in the Sino-U.S. trade standoff and its 2019 impact.
• Apple's perspective on subscription offerings that include hardware, services and support.

Looking Ahead

Baird analyst William Power said the toned-down consensus estimates for Q2 and 2019 are still too high, given challenging conditions in China and elsewhere.

"We remain positive long-term on AAPL's ecosystem benefits, impressive services growth and strong cash flow, but we would be more cautious near-term until estimates are more fully reset." 

Stock Take

On a positive note, the recent weakness in Apple shares provides an excellent entry point, according to Morgan Stanley analyst Katy Huberty. The shares have already priced in an extremely cautious iPhone replacement cycle and ASP headwinds, and the upcoming services launches would serve as a catalysts, the analyst said. 

Morgan Stanley has an Overweight rating on Apple with a $211 price target.

Notwithstanding the attractive valuation, BofA has a Neutral rating on Apple given a lack of near-term catalysts and expected continued weak iPhone sales balanced by large net cash/optionality. The firm lowered its price target from $195 to $190.

Baird has an Outperform rating and $185 price target for Apple shares.

Will the shares inflect higher after a quarter of lackluster performance? The Q1 release and the earnings call could provide clues on the stock's near-term trajectory.

Photo by Daniel Lu/Wikimedia.