Apple had the first revenue decline since Q3 2019. Here’s why I am not worried

Per Apple Newsroom:

Apple today announced financial results for its fiscal 2023 first quarter ended December 31, 2022. The Company posted quarterly revenue of $117.2 billion, down 5 percent year over year, and quarterly earnings per diluted share of $1.88.

On the earnings call, Tim Cook named three reasons for the revenue decline: unfavorable foreign exchange rates, supply chain issues in China caused by the Chinese government’s Covid policy and a challenging macroeconomic environment. On foreign exchange, Cook quantified the impact at 800 basis points or 8%. Had foreign exchange stayed constant, the company would have had a 3% revenue growth. Regarding supply chain constraints, Apple posted an update on 11/6/2022, warning investors that they would not have enough iPhone 14 to sell. As it turned out, even they underestimated the gravity of the situation since supply shortage lasted through most of the quarter. For good measure, inflation and war in Eastern Europe were, too, significant hindrances.

On the product revenue side, here is where Apple landed:

  • iPhone: $65.78 billion, down 8% YoY
  • iPad: $9.4 billion , up 30% YoY
  • Mac: $7.4 billion, down 29% YoY
  • Wearables: $13.48 billion, down 8% YoY
  • Services: $20.77 billion, up 6% YoY

While there is definitely value in tracking product revenue YoY growth, investors should not put too much stock in it. For two reasons. First, factors such as Covid and lockdown imposed by the Chinese government, affecting much of Apple’s supply chain, are beyond the company’s control. Of course, Apple must address this outsized risk for long-term sustainability, which I believe they already have started, but there are always unpredictable events. Second and more importantly, YoY growth is significantly influenced by Apple’s product release schedule. Take Mac as an example. Stay-at-home orders around the globe pulled forward a lot of demand. Additionally, the launch of Macs with redesigned M1 chips last year was an astounding success, making it a tough comparison this year. On the other end of the spectrum, iPad had a great quarter due to the new products and easy comparison which derived from supply constraints last year.

As a shareholder who has a sizeable share of portfolio in Apple, I am not worried about the company’s foreseeable outlook for the following reasons: customer loyalty & demand, Services and a competent management. During the call with analysts, Apple CFO Luca Maestri gave some color on how much Apple products appealed to consumers:

Importantly, the installed base of active iPhones continues to grow nicely and is at an all-time high across all geographic segments. In emerging markets, in particular, the installed base grew double digits, and we had record levels of switchers in India and in Mexico. Our customers continue to love their experience with our products with the latest survey of U.S. consumers from 451 Research indicating customer satisfaction of 98% for the iPhone 14 family.

At the same time, however, the installed base of active Macs reached an all-time high across all geographic segments, and we continue to see very strong upgraded activity to Apple silicon. Customer satisfaction with Mac remains very strong at 96% based on the latest survey of U.S. consumers from 451 Research.

The iPad installed base reached a new all-time high, thanks to incredible customer loyalty and a high number of new customers. In fact, over half of the customers who purchased iPads during the quarter were new to the product.

Our installed base of devices in the category (Wearables) set a new all-time record thanks to the largest number of customers new to our smartwatch that we’ve ever had in a given quarter. In fact, nearly 2/3 of customers purchasing an Apple Watch during the quarter were new to the product.

As you can see, Apple doesn’t have a demand problem. What they struggle with is to make sure that they have enough products to sell. It is a much better and easier problem to have than to generate demand. Today, China has relaxed its Covid policy, easing the supply chain bottleneck and giving Apple more products to put on the market. As mentioned before, Apple product releases seriously impact growth numbers and it’s anybody’s guess what products and WHEN the company will announce. Nonetheless, as long as devices fly off the shelves, Apple should be in good shape.

In addition to Products, I am bullish on the Services side of the house. Since 2018, Services revenue grew by 18% every year, reaching $20.77 billion in Q1 FY2023. To put it in perspective, in the last four quarters, Services generated close to $80 billion in income, dwarfing that of some of the iconic US giants like Starbucks, Nike or Boeing.

Apple attributed this growth to its ever growing subscription base and called it “the engine” of Services. As of Q1 FY2023, Apple had 935 paid subscriptions, growing it at 31% every year since 2018. With 2 billion active devices at the moment, that Apple had 935 million paid subscriptions implies there are a lot more subscriptions to acquire. Meanwhile, most existing subscribers should be happy to stick around. Can you imagine having 100 GB of photos and materials and suddenly stop iCloud next month? Furthermore, there are developing avenues for growth such as advertising, financial services or Apple Business Essentials. Because of these reasons, I am confident that Services will continue to grow nicely for Apple, at least in the next 3-5 years.

One last, but definitely not least, reason why I am bullish on Apple is its competent management. While other tech peers such as Microsoft, Meta, Amazon and Google got carried away by the growth during Covid and subsequently fired thousands of employees to cut costs, Apple was disciplined in its hiring and growth initiatives. Such a more measured approach led to Apple being the outlier in tech layoffs and maintaining healthy financial profiles. Despite unfavorable foreign exchange, supply constraints and inflation, Apple’s gross margin stayed relatively intact. Margin for Product, Services and the whole company was down by 1% compared to last year but up 2-3% compared to 2021. That’s not a mean feat. It implies considerable bargaining power against suppliers, thoughtful planning and great execution. And if you care about how a company is run, it’s exactly the kind of signal that you should look for.

Obviously, Apple’s management and investors would prefer a revenue beat to a revenue miss. But investing and characteristics of a company are more nuanced than just revenue figures. That’s exactly the case here. The strength of Apple’s product lineup & Services as well as the competent leadership at the helm make the attention-grabbing headlines from news outlets much less concerning.

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