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Apple's long-term bullishness on China comes up short on Street

Workers prepare outside the largest Apple store in Asia for its opening on January 23, 2015, in Hangzhou, China.
VCG | Getty Images
Workers prepare outside the largest Apple store in Asia for its opening on January 23, 2015, in Hangzhou, China.

Wall Street analysts have proved willing over the years to back up Apple on the latest focus of Apple management's bullish outlook. But there's a notable lack of analyst attention in the reports being issued after Apple earnings to what has been a major point of Apple bullishness in recent years: China.

Apple CEO Tim Cook again talked up the opportunity in China as sales in that key market stabilized. But in looking for a reason to be bullish as Apple stock shares declined on Wednesday morning by as much as 3 percent, the analysts weren't harping on China as a reason investors should be buying Apple on the dip.

Analysts noted the improvement in China, but at least four reports reviewed by CNBC didn't consider it a major near-term catalyst for Apple shares. Analysts are also asking whether something is structurally changing in Apple's China business. UBS analysts cited the fact that high-end smartphone penetration in China is now at 90 percent, according to a CNBC TV report on Wednesday morning.

Make no mistake: many Wall Street analysts remain bullish on Apple but are instead focused on rising speculation about next September's iPhone upgrade, a so-called supercycle with bigger upgrades than those included in this year's iPhone 7 launch.

"We see new form factor, better display and longer battery life driving shorter iPhone replacement cycles in fiscal year 2018, with double-digit revenue and EPS growth," wrote Morgan Stanley analyst Katy Huberty, who thinks the company will earn $10.60 per share in the year beginning next October, thanks to better growth in iPhones. "Shares historically trade closer to 14 [times estimating earnings] heading into a supercycle, which drives our new $148 price target."

Greater, or 'Not Great Enough,' China

Apple may be close to overcoming the crash in its Chinese business that has bedeviled its shares this year after reporting that sales stabilized in the quarter that ended Sept. 30 and saying signs point to a rebound by the holiday season.

Apple reported sales in Greater China that were down 30 percent from the same quarter of last year but down only 1 percent from sales in the quarter that ended in June. In the post-earnings conference call with analysts, Apple said it would approach its all-time quarterly sales high by the end of the calendar year.

"iPhone sales in Greater China declined during the quarter, but the initial customer response to iPhone 7 and 7 Plus gives us confidence that our December quarter performance in China will be significantly better on a year-over-year basis than our September quarter results, even as we lap the all-time record period from a year ago," Apple chief financial officer Luca Maestri said.

Translated, that means Apple is likely to approach its December-quarter Greater China sales of $18.1 billion last year. Sales in China during the just-concluded fiscal 2016 year dropped 17 percent, Apple CEO Tim Cook said, partly because of the rising value of the dollar but mostly because the company saw a sharp drop in the pace at which consumers upgraded to new phones after a big gain in 2015. The company failed to forecast that drop, cutting into sales and profits, Cook said. Apple also dropped to fourth place in smartphone market share in China.

"The response [in China] to the iPhone 7 and 7 Plus has been very positive," Cook said. "And so we'll find out more through the quarter, but we're confident enough to give you guys guidance that we're returning to growth this quarter, which obviously feels very good for us."

The color on China came in the context of a quarter in which Apple beat analysts' forecasts for profit by a penny, earning $9 billion, or $1.67 a share, on revenue of $46.9 billion.

Revenue will hit $76 billion to $78 billion overall in the December quarter, Maestri said, narrowly topping the $75.9 billion posted last year. Gross profit margin will be between 38 cents and 38.5 cents per dollar of sales, compared with 38 cents this quarter.

The guidance was slightly better than expected, RBC Capital Markets Amit Daryanani wrote in a note to clients. And Asia still shapes up as Apple's biggest growth market. Longer-term signs point to a resumption of growth in China, and in India, the largest part of a "rest of Asia Pacific" region, excluding China and Japan, where Apple said September-quarter sales rose 13 percent from last quarter to $2.67 billion.

Another broad theme the market picked up on in looking for positives from Apple's earnings — it was also a focus from analysts after the July quarter — doesn't relate to iPhone sales in any specific geographic market. It's the rise in the revenue across the board from Apple's services division, including Apple Music, cloud storage and the App Store. Revenue from services has doubled in the past four years. Services revenue was up 24 percent in the most recent quarter.

"The next big product is the App Store," Ben Schachter, an analyst with Macquarie Research, told the New York Times in his recap of Apple's results.

Even in the long-term view of the emerging markets opportunity, Apple is spending more time on a new focus for bullishness.

"I think it's clear that the population of India will exceed China sometime in probably the next decade or so, maybe less than that," Cook told analysts on the conference call. "There's going to be a lot of people there and a lot of people in the middle class that will really want a smartphone, and I think we can compete well for some percentage of those."

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