Apple's revenue has declined for three consecutive quarters in seven years, with iPad revenue plunging 20% more than expected and falling further after hours.

After the US stock market closed on Thursday, August 3rd, the world's largest listed company with a market value of over $3 trillion, Apple, a consumer electronics and technology giant, released its Q3 2023 earnings report (i.e., the performance for the second quarter of the 2023 fiscal year), marking the end of the earnings season for major tech stocks along with Amazon.

The third fiscal quarter from April to June is usually the slowest period of growth for Apple. Although Apple's revenue and EPS exceeded expectations, service revenue reached a historic high, and the Greater China region showed significant positive results, total revenue declined year-on-year for three consecutive quarters for the first time since 2016. All hardware product lines, except for Mac computers, experienced a decline, with iPad revenue plummeting by 20%. As a result, the stock initially rose over 1% after hours but then fell by 2%.

Subsequently, the company's CFO warned that the YoY performance in the fourth fiscal quarter would be similar to that of the third fiscal quarter, suggesting that revenue may continue to decline YoY, contrary to Wall Street's expectations of a recovery in growth. iPad and Mac are expected to experience double-digit percentage declines. As a result, the stock price fell by over 3% after hours.

On Thursday, Apple's stock fell by 0.7%, marking a three-day consecutive decline from the all-time high set on Monday and trading at its lowest level in nearly three weeks since July 14th.

Apple has risen by over 47% year-to-date in 2023, outperforming the Nasdaq's gain of over 33% during the same period and the S&P 500 index, in which it is the largest constituent, which has risen by 17%. This is a significant recovery compared to last year when the stock fell by about 27%, despite a slowdown in global demand for personal computers and smartphones.

The mainstream consensus on Wall Street before the earnings report was bullish. Among the 44 analysts surveyed by FaceSet, 29 rated the stock as "Buy," 14 rated it as "Hold," and only one rated it as "Sell." The average target price is $197.16, representing a potential upside of nearly 3%.

However, the company's current P/E ratio is 32.6 times, significantly higher than the three-year average of 27.2 times and the five-year average of 23.7 times. Barron's believes that this indicates that Apple, with its high valuation, does not have much room for error.

Total revenue declined YoY by 1.4%, marking the first three consecutive quarters of decline since 2016, and iPhone revenue fell by 2.5%, falling short of expectations.

According to the earnings report, as of July 1st, Apple's total revenue for Q3 was $81.8 billion, slightly better than the market's expectation of $81.7 billion, but down 1.4% YoY from $83 billion in the same period last year and down nearly 14% QoQ from $94.84 billion in the previous quarter.

This is the first time since 2016 that Apple has experienced three consecutive quarters of YoY revenue decline. The first fiscal quarter ending in December of last year was the first revenue decline since 2019, with a decline of 5.5%, marking the largest quarterly decline in six years since 2016.

In the third quarter, the EPS was $1.26 per share, a YoY increase of 5%. The market originally expected a slight decrease from the $1.20 per share in the same period last year to $1.19 per share. Net profit approached $20 billion, a YoY increase of over 2%. The gross margin of 44.5% exceeded the market's expectation of 44.2%.

Among them, the sales of the "flagship product" iPhone reached $39.67 billion, a YoY decrease of 2.5% and lower than the expected $39.9 billion. In the same period last year, the sales were $40.7 billion, a YoY increase of nearly 3%. Smartphones accounted for 48.5% of the total revenue, lower than the previous quarter's 54% and last year's 52%.

Some analysts believe that the financial report indicates that even the highly acclaimed iPhone is struggling to withstand the overall decline in the smartphone market. Yesterday, the financial report of Qualcomm, a mobile device chip manufacturer and iPhone supplier, has triggered concerns about demand.

The company's CEO, Cook, also admitted in an interview that the situation in the U.S. smartphone industry is currently severe. However, there is a high number of Android users switching to iPhone, especially in the Greater China region.

Mac hardware exceeded expectations but still decreased by 7% YoY, iPad revenue dropped by 20%, wearable devices had poor growth, services reached a new high

Among other hardware products, Mac computer sales reached $6.84 billion, a YoY decrease of 7.3%, significantly better than the expected $6.3 billion or a YoY decrease of over 10%.

However, iPad tablet sales were $5.79 billion, a sharp YoY decline of 20%, lower than the market's expectation of $6.4 billion or a YoY decrease of 11%. The company stated that this was due to the difficulty of comparing with the same period last year when the updated $600 iPad Air stimulated demand.

The revenue from wearable devices, home products, and accessories, including wireless headphones, smartwatches, and smart speakers, reached $8.28 billion, a YoY increase of 2.5%, slightly lower than the market's expectation of $8.4 billion or a YoY increase of 3%.

Zerohedge, a financial blog known for its sharp tongue, pointed out that the market has been concerned about Apple's hardware revenue reaching a "double peak" since the previous quarter. This time, almost every product line experienced a decline in sales compared to the previous quarter, triggering concerns about demand.

In recent years, the engine driving the company's revenue growth, the service business revenue, reached a new historical high of $21.21 billion, an increase of 8.2% YoY, surpassing market expectations of $20.7 billion or a 6% YoY increase. It remains a highlight in the earnings report, accounting for 26% of total revenue.

Service revenue includes App Store, Apple Music and Apple TV+ for audio and video streaming, iCloud storage, AppleCare warranty, advertising revenue from the licensing agreement with Google search engine, Apple Pay, and payment fees for other products. It was previously expected that the third quarter would benefit from the increase in iCloud subscription prices, stable foreign exchange rates, and improvements in digital advertising and gaming businesses.

Wall Street hopes to see steady growth in Apple's service business, as its profit margin is much higher than that of hardware sales. Especially after experiencing a slowdown in App Store software sales, many analysts hope to see a reacceleration of service revenue after several quarters of weak growth. The better-than-expected performance of Meta and Google's digital advertising indicates that Apple's service business may have an upside surprise.

It has been pointed out by the media that investors are increasingly concerned about the slowdown in Apple's service business growth, as services are an important area of diversification for Apple's business after the iPhone has become a more mature product. Some analysts view Apple's service business as a leading indicator of consumer demand. In other words, service business reflects consumer demand earlier than iPhone sales.

Greater China revenue exceeds expectations with 8% growth, Cook says it's clearly accelerating, iPhone sales in India reach a new high, weak guidance for next quarter

In terms of regions, Greater China contributed $15.76 billion in revenue to Apple, an increase of 7.9% YoY, significantly higher than analysts' expectations of $14.6 billion or flat YoY, reversing the decline in the previous quarter. Cook stated that he saw a "clear acceleration."

Revenue in the largest market, the Americas, was $35.39 billion, a decrease of 5.6% YoY, significantly weaker than the expected $38 billion or a 1.4% YoY increase. Revenue in Japan fell by over 11%, while other Asia-Pacific regions fell by 8.5%. The European market saw a slight YoY increase of 4.8%. However, the company's CFO stated that iPhone sales revenue in the Indian market reached a new historical high in the quarter.

Apple CEO Tim Cook stated in the earnings report that due to the number of paid subscribers exceeding 1 billion, the company achieved record-high service revenue in the third quarter and benefited from strong iPhone sales, witnessing sustained growth in emerging markets.

Apple CFO Luca Maestri mentioned that the year-on-year performance in the third quarter improved compared to the previous quarter, with all geographic regions reaching their highest-ever active device install base. The operating cash flow for the quarter reached $26 billion, with over $24 billion returned to shareholders.

Furthermore, the overall operating expenses for the quarter were $13.42 billion, slightly below the expected $13.5 billion. The operating cash flow significantly exceeded market expectations of $22.9 billion. The company held $166.5 billion in cash at the end of the quarter, slightly higher than the $166.3 billion at the end of the previous quarter.

Since the outbreak of the COVID-19 pandemic in 2020, Apple has stopped providing performance guidance, and this time is no exception. Cook reiterated during the earnings conference call that foreign exchange factors had a negative impact of 400 basis points on the company's revenue, and the macroeconomic environment across different regions globally has been uneven.

The CFO warned that the year-on-year performance in the fourth quarter is expected to be similar to the third quarter, implying a continued decline compared to the previous year, which is different from Wall Street's expectation of a recovery. He expects revenue from iPhone and services to grow compared to the third quarter, but anticipates double-digit percentage declines for iPad and Mac.

Currently, Wall Street expects Apple's EPS earnings for the fiscal year ending in September 2023 to decline by 2.2% year-on-year to $5.98 per share, and annual revenue to decline by 2.4% year-on-year to $384.99 billion.

Prior to the release of the earnings report, Guo Mingchi, known as the "analyst who understands Apple the most" at TF International Securities, stated that the Apple earnings report would not attract much attention and would not mention much about AI content. Indeed, the earnings report did not mention this keyword. In an interview, Cook stated that Apple has been committed to the research and development of generative artificial intelligence and other models for many years:

"We consider artificial intelligence and machine learning as fundamental core technologies. They are embedded in almost every product we make. Based on our research, we have been studying artificial intelligence and machine learning for many years, including generative artificial intelligence."

The Apple earnings report is a barometer of consumer electronics demand, and this time Wall Street is only focusing on three keywords: China, India, and AI

The Apple earnings report has always been regarded as a barometer of consumer electronics demand. This quarter, many companies, including Qualcomm, believe that inflationary pressures will continue to suppress such demand. Apple's performance guidance may provide clues as to whether the global economy can achieve a "soft landing." At the same time, as the largest component of the S&P 500 index, Apple's stock price performance after each earnings report will also have a tangible impact on the overall market trend. TECHnaanalysis Research founder Bob O'Donnell pointed out that Apple is not immune to the overall macroeconomic trends and will continue to lead the development of the smartphone industry for a considerable period of time. However, Monness, Crespi, Hardt & Co. analyst Brian White believes that despite the pressure on the smartphone industry, Apple is expected to continue outperforming the overall market.

Many analysts believe that investors are more concerned about Apple's official guidance for the fourth quarter compared to the previous quarter's performance, as the months of July to September usually see an increase in laptop spending due to students returning to school, as well as the performance of the latest iPhone models in the first few days of their release.

Morgan Stanley analyst Erik Woodring believes that Apple may forecast a year-on-year revenue growth for the overall fourth quarter. Wedbush analyst Dan Ives also stated that the 15th anniversary edition of the iPhone, iPhone 15, may be released in mid-September, and approximately 25% of current iPhone users have not upgraded their phones for more than four years, indicating a potentially smoother transition from iPhone 14 to 15.

Wall Street is also paying attention to Apple's traditional growth driver, the Greater China region, as well as its performance in the emerging growth market of India. Previously, the Greater China region was Apple's third-largest sales region, but its revenue has declined year-on-year for two consecutive quarters.

However, according to research firm IDC, Apple's market share in the Chinese smartphone market increased to 15.3% in the second quarter of this year, with iPhone sales growing by 6.1% during the same period. In contrast, the overall smartphone shipments in China declined by 2.1% during the quarter, indicating that Apple's smartphone sales in China continue to outperform global competitors.

Wedbush analyst Dan Ives stated that iPhone demand in major regions of China significantly increased in the second quarter of this year, which will align Apple's overall smartphone revenue with expectations, and may even exceed expectations. Previous Wall Street predictions of a significant decline in iPhone sales may have been overly pessimistic. In addition to the increase in iPhone market share in China, Apple has also maintained stable market share in the United States and Europe.

Piper Sandler analyst Harsh Kumar stated that many investors are concerned about Apple's weak sales in China, but the brokerage firm believes that Apple's position in the Chinese market is solid and may only experience a slight decline or even no decline, and any decline will eventually be offset by the sales momentum in India.

Apple CEO Tim Cook visited India in April this year and mentioned the "significant growth" potential in the region. Data from research firm Counterpoint Research shows that India has become one of the top five markets for the iPhone in the second quarter of this year. D.A. Davidson analyst Tom Forte stated that he will look for more details about Apple's expansion into India, including retail and manufacturing, during the earnings conference call. Of course, Wall Street also expects to hear about the advancement of "artificial intelligence" at Apple. Analyst Aaron Rakers from Bank of America predicts that Apple's latest comments on its AI vision will be the focus, especially with the official release of the augmented reality headset Vision Pro. Any comments related to this technology could boost the stock.

Furthermore, since consumers are no longer upgrading their phones during the economic downturn, resulting in a decline in iPhone sales in the third quarter, and Apple has stopped providing performance guidance since the outbreak of the COVID-19 pandemic in 2020, "the company must provide detailed explanations on how to leverage artificial intelligence to drive growth."

According to media reports, Apple is internally developing AI tools similar to ChatGPT and a large language model called "Ajax." However, the company has so far avoided using popular terms such as artificial intelligence during its events, which sets it apart from tech giants like Google and Microsoft.

When discussing AI, Apple tends to use the term "machine learning" and prefers to discuss what software with added AI features can do for users. During the earnings conference call last quarter, CEO Tim Cook only mentioned AI twice, and he didn't mention the term at all during the software release event in June. However, analysts expect Apple to adopt a more aggressive approach to discussing its AI strategy in the future, especially considering the use of AI technology in the augmented reality headset.

What do mainstream Wall Street analysts expect in the future? AI, AR headsets, and diversification into more business areas to increase service revenue

In addition to the iPhone 15th-anniversary edition and the updated Apple Watch expected to be released in the third quarter of this year, Apple's progress in the financial services sector seems to be going smoothly. The company stated that since its launch in April, its high-yield savings account in partnership with Goldman Sachs has attracted $10 billion in deposits and offers an annual savings interest rate of 4.15%.

With a global installed base of 2 billion active devices, Apple is also targeting the healthcare industry. As early as 2019, CEO Tim Cook stated that improving people's health would be "Apple's greatest contribution to humanity." Analysts believe that:

These businesses, along with Apple's foray into augmented reality (AR) headsets and further expansion into emerging markets, could have a net positive impact, although they may take some time to yield results.

Analyst Samik Chatterjee from JPMorgan Chase believes that Apple is a resilient profit compounder rather than a product cycle company. He expects investors to further believe in the resilience driven by hardware product replacement cycles and the growth driven by diversification into the service business.

Goldman Sachs analyst Michael Ng believes that Mac computers, service revenue, and improvements in the exchange rate environment will drive Apple's earnings per share growth. Despite growing concerns among investors about valuation and downside risks, Apple's growing installed base and average device selling price will serve as the foundation for monetizing individual users. As a long-term profitable and free cash flow-generating company, Apple deserves a premium valuation. Morgan Stanley is also optimistic about Apple's guidance for the fourth quarter, based on expectations of "stable iPhone production, strong seasonal demand for Mac computers, 10% to 15% growth in service revenue, and continued long-term and cyclical profit tailwinds."

As mentioned earlier, Wedbush analyst Dan Ives believes that Apple's service revenue could accelerate in 2024, as the number of iPhone users has increased by 100 million in the past 18 months, coupled with price increases and improvements in App Store activities. Service revenue in the coming quarters may grow in double digits, and the ultimate value of the service business could be between 1.3 trillion and 1.4 trillion US dollars, which is still an underestimated asset on Wall Street.