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Time to buy Apple?

It appears as though we've gotten through Apple's first-quarter report only slightly scathed, but will we be so lucky next quarter? The stock was down 2.59 percent in the after-hours on mixed results, but it is second-quarter expectations that have become the real worry.

So far, we've seen second-quarter earnings per share and revenue estimates falling at a much faster rate than first-quarter estimates, largely due to the late product cycle effect for the iPhone. Over the last 3 months, the Estimize consensus on both the top and bottom-line has fallen roughly 10 percent.

While earnings per share and revenues are important numbers to watch, it's iPhone unit sales that really move this stock, making up 70 percent of Apple's total revenue. There were a flurry of warning signs earlier this year that the latest models of the iPhone were in trouble, as multiple suppliers such as TSMC, Qorvo and Cirrus, all reported a drop in orders. However, the full effect of that decline was not reflected in the first quarter, and will instead be fully realized in second quarter. That was made clear on Tuesday's earnings conference call, when the company warned that the March quarter will face the most difficult year-over-year comparison. I'd take this warning pretty seriously as Apple's guidance later in the product cycle is usually spot on versus earlier in the product cycle, when they normally sandbag.

A good chunk of first quarter iPhone revenues were out of China, a region Apple has become dependent upon. However, some investors are now concerned that China's turbulent economy and the competitive smartphone landscape present new challenges for the tech giant.

On Tuesday's call, Tim Cook reiterated his confidence in the long-term potential of that market and I'd agree that Apple's prospects of maintaining their market share are very high. Apple products are viewed as luxury items in China — on par with a Rolex watch or a Hermes Birkin bag. As the Chinese middle class continues to expand, Apple will have more potential customers willing to put their discretionary income toward technology. With that said, investors should keep in mind the foreign-exchange headwinds associated with doing business outside of the U.S. In the first quarter alone, the currency impact knocked 6.3 percentage points off of Apple's total revenue despite attempts to hedge.

Apple is reliant on producing hit products, so if the iPhone isn't cutting it, what other products could pick up the slack? The answer is none at the moment, with all other product metrics looking rather "meh." The iPad and Mac continue to take a beating with no sign of a recovery in the near future. It seems possible that the Apple Watch and Apple TV could be doing well, but since they are lumped into the "other" category with iPods and Beats, we're unable to break those numbers out. Somewhat encouraging is a pickup in media sales, with the company focusing on things like Apple Music to squeeze more money out of iPhone users. While these things are all well and good, they won't be enough to offset any weakness in iPhones.

Looking ahead, the March quarter could be the ugliest since the days of the iPhone 4s/5. June might not be so great either, as no new product releases are scheduled, but by that time investors might have their focus on a fall release of the iPhone 7. Gross margins, one of the most highly correlated variables with Apple's stock, continue to shrink as they often do this late in the product cycle. Falling margins paired with a multiple that looks like it is approaching a low for the cycle means we should be getting a real tradeable bottom sometime between this and next quarter, presenting a good buying opportunity.

As a guest on the Estimize podcast, Sean Udall of Quantum Trading Strategies, put it this way: "The Apple narrative is gonna have to change soon." With $216 billion in cash on hand, they can't continue to buy back $80 billion worth of stock each year and need to instead focus on mergers and acquisition. If Apple can't generate its own growth, it has to start buying it. It's going to be long, hard slog through the next couple of quarters, but Apple always works it out. With so much cash on hand and manageable debt obligations, recent headwinds should not be an indication of Apple's future performance.


Commentary by Christine Short, Senior Vice President at Estimize. An expert in corporate earnings, Christine analyzes aggregated S&P 500 EPS and revenue performance at the sector, industry and company level. Prior to joining Estimize, Christine served as the Director of Earnings Research at both S&P Capital IQ and Thomson Reuters. She holds a Bachelor of Arts in International Relations and Journalism from Fairfield University. Follow her on Twitter @ChristineLShort.

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