Apple significantly reduced its guidance for the December quarter, blaming China and a few other factors for the shortfall. This is Apple’s first negative pre-announcement in over a decade, since at least the launch of the iPhone. The announcement came after the US market closed and Apple’s shares are trading about 8 percent lower in the after-market.

Not a surprise, but worse than expected

A reduced guide isn’t a surprise given announcements from Apple’s suppliers of production cuts over the last two months. Since its peak in October Apple’s stock had fallen 33% and analysts had started cutting estimates. However, the size of the revenue shortfall is deeper than even the most bearish analysts were predicting. Revenue guidance is now $84 billion for the quarter, 5-10% below the earlier guidance range and 8% below consensus. The trajectory of revenue growth has inflected, from growing ~3% to declining 5% versus the prior year.

iPhone volumes down 18%!

iPhone volumes for the quarter now look to be around ~63 million units, down a fairly shocking 18%. Apple surprised us last quarter by announcing they are going to stop reporting unit volumes. They reason that unit sales are not “necessarily representative of the underlying strength of our business”. Yes, really. With units looking to be down 18% can they still justify that it doesn’t matter?

Consumer driven weakness in China is the real story

The commentary on China is the “new news” and even more significant for investors than what it means for Apple and its suppliers. While the production cuts were common knowledge, it wasn’t clear if this was a company specific issue, caused perhaps by iPhone prices rising too fast, or macro factors. On their earnings call in November they said China was going well, sounding surprisingly bullish versus some of the other indications coming out of China. Cook did call out weakness in other emerging markets (Turkey, India, Brazil, Russia) but said that China wasn’t in the same category and was strong, growing 16% in the prior quarter.

But that has all changed. In the shareholder letter Apple describes how they “did not foresee the magnitude of the economic deceleration, particularly in Greater China.” China’s economy began to slow in the second half of 2018, with the September quarter GDP growth the second lowest in 25 years. The impact of the weakening economic environment and rising trade tensions “appeared to reach consumers as well, with traffic to our retail stores and our channel partners in China declining as the quarter progressed. And market data has shown that the contraction in Greater China’s smartphone market has been particularly sharp.”

The iPhone is the world’s largest consumer product. And we now know that consumers, particularly in Greater China, are spending less on this product. Investors will need to assess how reliable this is as a measure of broader economic weakness and declines in consumer spending.

Is Apple downplaying the other factors?

We shouldn’t ignore the other factors that are impacting iPhone sales, with the comments buried in the discussion about Greater China weakness. iPhone upgrades in developed markets were admitted to not be as strong as management expected. Telecom carriers are offering fewer subsidies, which means the real price of a phone upgrade is now clear for consumers. The strong US dollar is increasing prices in some countries. And cheap iPhone battery replacements (forced on Apple after we discovered they were deliberately slowing down our phones) are extending the product life. The replacement cycle has been lengthening for a few years, and these factors are accelerating that trend. Perhaps they are more significant than Apple would like us to think.

You can read the full letter from Tim Cook to investors here: https://www.apple.com/newsroom/2019/01/letter-from-tim-cook-to-apple-investors/

Author: Lachlan MacGregor, Portfolio Manager