Expectations for Apple Inc. (NASDAQ:AAPL) this earnings season is tempered. The tech giant will be reporting its third-quarter results on Tuesday and analysts are looking for a year-over-year decline in earnings. Revenue may fall flat, too. Should Apple Inc. (NASDAQ:AAPL) report a decrease in earnings per share growth for the second quarter, it will mark the third consecutive quarter that Apple Inc. (NASDAQ:AAPL) has reported a year-over-year decline in EPS.
Citi: Apple is feeling the impact of a saturated market
According to Citi, Apple Inc. (NASDAQ:AAPL) is feeling the impact of a saturated market. In light of a mix shift toward lower-end iPhone 4S and relatively weak iPad sales, Citi see risk that Apple’s 3Q 13 revenues/earnings could fall below the mid-point of their $33.5 billion-$35.5 billion revenue (consensus $35.1 billion, Citi $34.5 billion) and implied $6.66-$7.42 EPS guidance (consensus $7.31, Citi $7.09). They also see risk to 4Q 13 (Sep) consensus revenues (currently modeling 7 percent sequential increase) given the relatively late launch of the iPhone5S and low-cost iPhone and the delay of the iPad Mini Retina.
Citi’s checks indicate Apple cut production for iPhone 5
Initial results for iPhone5, Galaxy S4, and HTC One suggest that demand for high-end smartphones is falling short of lofty expectations, likely due to saturation in developed markets. This was evident in Apple’s 3Q 13 where Citi’s checks indicate Apple Inc. (NASDAQ:AAPL) cut production for the iPhone5 but increased production for the iPhone4S.
Heading into 4Q 13, Citi see similar strains: high-end iPhone (5/5S combined) production is expected to decline q/q, exacerbated by a delay in the iPhone 5S production. They believe the iPhone 5S has been delayed (due to problems with an integrated driver IC, touch controller chip), impairing volumes for Apple in the September quarter – Citi model 10 million-12 million iPhone 5/5S in 4Q 13 vs. 16 million-18 million in 3Q 13.
Meanwhile, the trend toward the iPhone4/4S is expected to continue, leaving room for their conservative 5.5 million unit assumption to increase. When considering the introduction of a low-cost iPhone (Citi expect modest sales in 4Q 13, owing to its late launch in the September quarter) and the negative mix shift is increasingly evident. In aggregate, Citi see risk to the consensus 29 million iPhone shipments in 4Q 13 (Citi currently model 21 million units) and continue to see risk to Apple Inc. (NASDAQ:AAPL)’s mix of high-/low-end phones.
iPad expectations may prove aggressive
Citi suspect the iPad will be a source of relative weakness for Apple in 3Q 13, noting that production cuts were evident throughout the quarter – Citi field work suggests Apple cut production of the iPad Mini from 8 million to 6-7 million (10” iPad production was 5 million), resulting in ~12 million total units produced during the quarter. Although Apple Inc. (NASDAQ:AAPL) will surely sell from inventory, they suspect the consensus iPad estimate of 18 million units for 3Q 13 may prove too aggressive.
Meanwhile, Citi stand by their assertion that iPad Mini Retina has been delayed to either late 2013 or into 2014. This leaves a new 10” iPad5 (thinner and lighter than iPad4) and a reduced cost iPad Mini (~$225 vs. $329 for current Mini) for a late-3Q 13 launch. Given the potentially late-in-the-quarter launch of these new products (and the delay of the iPad Mini Retina), Citi suspect the consensus expectation for 5 percent sequential increase in 4Q 13 iPad sales may prove aggressive.
Apple’s margins at risk
Citi don’t argue that as Apple Inc. (NASDAQ:AAPL)’s production experience matures that gross margin ought to improve on a given device. They note, however, that Apple’s high product cadence, combined with recent execution issues may obviate these benefits . But more importantly, Citi see margin risk from an increasingly obvious trend away from high end smartphones and tablets.
Citi’s concern is predicated on a combination of: high smartphone saturation levels in developed markets, falling smartphone ASPs and increasingly elusive smartphone innovation. Citi see risk to Apple Inc. (NASDAQ:AAPL)’s consensus 2H 13 gross margins (36.8 percent/37.6 percent vs. Citi 35.9 percent and 36.3 percent) and longer-term see risk from further margin degradation.
Particularly when putting these shortfalls in the context of a softening market for high-end smartphones, and the related impact to margin, Citi continue to find it difficult to side with Apple Inc. (NASDAQ:AAPL)’s many bulls. Citi target price for Apple is $430, based on the implied multiples derived from growth and value regressions of a sample of large-cap technology companies