Three themes for investors to follow as Apple releases earnings on Tuesday

Published Tue, Jul 27 202111:24 AM EDT

Apple has beaten Wall Street expectations since last February as the company kept stores stocked with the latest gadgets amid high demand among homebound customers. But the tech giant's business is seasonal, and the quarter ending in June – the results the company will release Tuesday after the bell – is typically its slowest. Analysts polled by FactSet estimate Apple will report $72.9 billion in revenue, which would be a sequential decrease of about 18% from last quarter. It would still be a 22% increase from last year's record third-quarter revenue. Since last year, Apple has stopped giving quantitative guidance such as revenue or gross margin. Instead, it has provided investors with qualitative data points, because of uncertainty caused by the Covid-19 pandemic. 1. Guidelines for upcoming fourth-quarter sales When Apple reports earnings on Tuesday, investors will be watching what the company says about its fiscal fourth quarter, which ends in September. A strong guide or data points for Apple's fourth-fiscal quarter could point to a tailwind for iPhone sales as economies reopen, Goldman Sachs analyst Rod Hall said in a note. Apple's September quarter also includes back-to-school sales for iPads and Macs, which investors will focus on as some signs are pointing to PC and educational sales dropping after a year in which families and businesses needed new laptops for school and work. Apple says that demand still outstrips the supply of iPads and Macs it can produce, due to supply constraints driven by the worldwide chip shortage. The company expects a $3 billion to $4 billion "backlog" in iPad sales, which could be a tailwind for fourth-quarter revenue, Hall said. Investors are looking forward to the next iPhone launch, which is expected in September. Apple's guide could also suggest how the company sees demand shaping up for its next-generation iPhones. However, Apple's September quarter depends on the timing of when the new iPhones hit store shelves. Last year, iPhones didn't go on sale until October. Even in years in which the iPhone is released relatively early, the September quarter usually only includes a few days of next-generation sales. "While all eyes will likely be on Apple's FQ4 guidance, we note that guidance has historically not been a helpful predictor of strength in the subsequent year's iPhone cycle and we believe Apple is likely to continue providing qualitative 'guidelines' rather than quantitative 'guidance,'" Bernstein analyst Toni Sacconaghi wrote in a note to clients. 2. China sales Official government data tracks handset sales in China. In April, May, and June, overall smartphone sales were weak, according to Goldman Sachs. Using China data from "international vendors," which is believed to be mostly Apple, the bank calculated that sales for the iPhone 12 redesign that came out late last year are 14% lower than the last major redesign cycle for the iPhone X that came out in 2017. In total, smartphone shipments, including Apple and its competitors, were down 9% annually in June, according to Morgan Stanley's analysis of the China data. But during the past year, Apple's success has been driven by China, which typically accounts for 15% to 20% of the company's revenue. In its December quarter, Apple reported record revenue of $21 billion from Greater China, which includes Hong Kong and Taiwan. The tech giant also set a March quarter record with $17.73 billion in sales, an 87% annual increase, although that's a comparison to a pandemic quarter. Apple CEO Tim Cook said every product line grew by double digits during the March quarter. Apple has a couple of developments in its favor. A major advantage is that Huawei has been unable to produce competitive devices due to American trade restrictions, which has led to 10 months of market share gains in China, according to Morgan Stanley research. Huawei is the largest smartphone vendor in China by installed base, with Apple in second. Since October 2020, Apple has had higher retention than Huawei when people upgrade their smartphones in China, according to Morgan Stanley, which says that Apple's retention rate of 58% is 16 points higher than Huawei. 3. App store performance and services One of Apple's profit engines is its services business, a high-margin category that includes everything from iCloud subscriptions to AppleCare warranties and Apple's App Store distribution platform. Last quarter, 18% of Apple's revenue was from services, for $16.9 billion in revenue at a 70% gross margin. "Longer term, we expect the higher-margin services revenue growth to outpace total company growth and drive gross margin expansion," Canaccord Genuity analyst Michael Walkley wrote in a note this month. Cowen analyst Krish Sankar expects Apple's leadership to highlight how many paid subscribers it has. Apple said earlier this year that it has 660 million paid subscribers, which includes both people who subscribe to first-party services like Apple Music as well as any subscriber who is billed regularly through Apple's App Store. "As Apple's own subscription revenues near 50% of the overall Services business, we think Services … could trend more like a recurring revenue stream with less seasonal volatility in the coming years," Sankar wrote in a note this month. Apple's App Store is facing difficult comparisons after a hot first half of 2021 and potentially slower growth, writes Bank of America analyst Wamsi Mohan. Mohan estimates that App Store revenue could still grow 16% in the June quarter, based on third-party download data, but that would still be a slowdown from 36% year-over-year growth in the March quarter. Overall, Mohan still believes that Apple's entire services line item will grow 23% this quarter, for about $16.2 billion in sales, driven by increases in iCloud subscriptions and licensing, a category that includes Apple's search deal with Google. However, Apple rarely breaks down the components of its services business, so investors will be looking for data points and qualitative information about App Store trends from company leadership.

Apple signage on the Apple campus in Cupertino, California.

David Paul Morris | Bloomberg | Getty Images

Apple has beaten Wall Street expectations since last February as the company kept stores stocked with the latest gadgets amid high demand among homebound customers.

But the tech giant's business is seasonal, and the quarter ending in June – the results the company will release Tuesday after the bell – is typically its slowest.