Apple (AAPL) Q2 2016 Earnings Preview: iPhone Decline, Slowing China Growth And Weak Guidance

Apple loves being able to report “record revenue” when posting its quarterly financial results. Indeed, for the last five quarters the company has used that phrase in its news releases. On Tuesday, however, when Apple reports for the first three months of 2016, it will have to find a new phrase to describe its results.

The California-based tech giant has already warned investors not to expect record results this time around, with its January guidance suggesting revenue between $50 billion and $53 billion, well down from the $58 billion it reported in the same period last year. The consensus among Wall Street analysts polled by Thomson Reuters is for Apple to report revenue of $52 billion, which would represent a decline of over 10.4 percent year on year, with earnings per share of $2, a drop of 14 percent compared to the year-earlier quarter.

While other factors do come into play, by far the biggest reason for the revenue drop is the slowing growth of iPhone sales. Apple’s iconic smartphone contributes a huge portion of the company’s revenue. In the first quarter of last year, the iPhone business contributed almost 70 percent of Apple’s overall revenue, so any weakening in sales is bound to have a huge impact.

Analysts' consensus suggests Apple sold 50 million iPhones in the quarter, significantly down from the 61 million it sold in the 2015 first quarter. “If actual results are above what the analysts were expecting, it could be really good for the stock, but if it’s any lower than consensus then that could hit the stock hard,” Jan Dawson, chief analyst at Jackdaw Research, told International Business Times.

Even more important than the number of iPhones Apple sold in the March quarter, will be the guidance it gives for the current quarter, says BTIG analyst Walter Piecyk. “Most people are aware of the struggle, aware of the headwind as far as iPhone growth, the lack of revenue, but now the focus turns to the outlook or guidance for the next quarter.”

Analysts expect to see another decline in the June quarter though not as severe, with the average estimate among analysts polled by Thomson Reuters suggesting revenue of $47.5 billion, a 4.5 percent decline year on year. One of the reasons for investor concern is that, as well as the slowing smartphone market, people are taking longer to upgrade their iPhones.

“Our concern is that because of lengthening replacement cycles for iPhone users that the guidance for revenue for next quarter may come in a little light,” Piecyk told IBT. The question that investors will now be asking is whether the current slowdown of iPhone sales is a temporary blip or a sign of a long-term malaise for the company’s smartphone business.

“The narrative Apple has to drive home is that we’re seeing a brief dip in sales after a truly exceptional year in late 2014, early 2015, and that sales will get back on their previous trajectory later this year,” Dawson said. “That argument is harder to make if sales drop further than expected and aren’t expected to recover in the next quarter. ”

One of the main drivers of growth during 2014 and 2015 was China, which is now the company’s second-biggest market in terms of revenue. However, just like the rest of the world, growth in China is slowing, with Apple reporting a modest 14 percent year-on-year rise in Chinese revenue for the final three months of 2015. This is only likely to increase scrutiny of Apple’s business in the Far East.

“I would guess that every quarter from now for the foreseeable future you will hear commentary about China, for better or worse,” Piecyk said. “India comes in, but China is the primary focus of a lot of people’s questions — investors want to know will this be sustained and grow from that point.”

Apple is turning its attention to India, the world’s second-biggest smartphone market, but the company has so far failed to make major inroads, holding just a 2 percent market share, according to CounterPoint Research.

Apart from iPhones, there is little that is likely to excite investors, Piecyk says, even with the launch of the company’s iPad Pro models. “The iPads have been in perpetual decline so it would be certainly a surprise to everyone if some of these new versions of iPad enabled the company to revert it back to growth,” Piecyk said.

With the PC market declining by 10 percent in the first quarter of 2016, sales of the company’s Mac computers are also unlikely to raise investors' spirits. Looking at the company’s newest product line, the Apple Watch, indications are that it has also struggled in the first three months of the year.

According to a note by Matthew Goodman, a senior analyst with ITG Investment Research, sales of the Apple Watch have dropped 40 percent compared to the previous quarter. Goodman said the recent price drop of $50 for the cheapest model has helped sales, but if global markets followed those in the North America, Apple sold just 3.1 million units in the three months to the end of March.

Apple's shares have grown steadily in the last three months, from $99.99 on the day it reported its last set of quarterly results to $105.97 at the market's Thursday closing, a rise of almost 6 percent. However, Apple shares are underperforming the S&P 500 stock index, which rose 10 percent in the same period.

Last month Howard Ward, Gamco's chief investment officer for growth equities, told Bloomberg that the iPhone 7 would be a significant boost for the company: “It’s become a low-expectation stock in terms of the way it’s priced, and it has in fact done nothing for the last 12 months, but we’re now moving into, I think, a better season for Apple.”