"We Are Disappointed" - Goldman Removes Apple From "Conviction Buy" List, Cuts Price Target From $155 To $136

The tide has finally turned on what until recently was every sellside analyst's favorite stock.

With AAPL back in bear market territory and the stock back at levels last seen when the S&P was at 1820, it only makes sense for Goldman to take profit on its AAPL short position, which in this case manifested itself with a "Conviction Buy" call on the stock (for Goldman to short the stock, clients have to buy), and moments ago it closed out its "conviction buy" saying "we are disappointed by Apple’s quarter and guidance, as it reflects a much weaker iPhone 6s product cycle than we had anticipated, with most of the negative surprise vs. our expectations coming from China", and cutting its 12 month price target on the stock from $155 to $136.

This is what else Goldman said.

Tough quarter; removing from Conviction List, maintain Buy rating

 

Current view

 

We are disappointed by Apple’s quarter and guidance, as it reflects a much weaker iPhone 6s product cycle than we had anticipated, with most of the negative surprise vs. our expectations coming from China. As such, we expect the shares to be weak in the near term, until the market gets comfortable around improving trends with the iPhone 7 product cycle. That said, we do not view the quarter as thesis-changing longer term, and maintain our Buy rating. In particular, we are encouraged by (1) Apple’s new disclosure that its iPhone installed base is up 80% vs. 2 years ago, coupled with evidence in our US survey of significant pent-up demand for the iPhone 7, and (2) the acceleration in reported services growth to 20% yoy, with gross services up 27% - evidence of increasing monetization of Apple’s platform. We now estimate 41mn iPhone units in F3Q, compared to prior GS/consensus at 47mn/44mn, with about a 2mn impact from the channel inventory reduction. We lower our FY16-18 sales estimates by 8%-9% on lower units/ASPs, and our EPS estimates by 11%- 14% to $8.40/$10.53/$11.42 on the additional impact of lower margins. We lower our 12-month price target to $136 from $155, based on 12.5X CY17 EPS (previously 15X on CY16E EPS), reflecting lower growth. Risks include product cycle execution, end demand, competition, and a slower pace of innovation.

 

iPhone: Disappointing iPhone 6s demand weighs on results

 

Apple’s iPhone segment fell short of expectations in the quarter, as revenue of $32.9bn (-18% yoy, -36% qoq) compared to GS at $35.3bn and consensus at $33.2bn. Similarly, 51.2mn units were below our forecasted 53.6mn although modestly above Street at 50.3mn. ASPs of $642 compared to GS and Street at $659 driven by FX headwinds as well as a mix towards both mid-tier and entry-level iPhones (i.e., the 6 and 5s, respectively) in the quarter. Looking ahead to June, while management does not provide explicit segment-level guidance, it expects “seasonal” sequential declines in iPhone sales. Looking at the trailing three-year average as a proxy for underlying seasonality, that -19% qoq decline would imply 41.2mn iPhone units. Management also expects iPhone ASPs to decline from March driven by the maturing 6s cycle coupled with the introduction of the lower-priced iPhone SE. The ASP mix in F3Q will also be negatively impacted by the $2bn planned channel inventory reduction, as that primarily impacts the higher-priced iPhone 6s models. We now expect iPhone unit volume of 213.9mn/246.3mn in CY16/CY17, representing yoy growth of -7.6%/+15.1%, respectively.

 

$2bn channel inventory reduction creates up to 2mn unit drag yoy

 

Exiting the March quarter, iPhone inventory was within the company’s targeted five-to-seven week range; however, citing the “macroeconomic environment” management intends to reduce company-wide channel inventories by $2bn in the June quarter compared to a ~$800mn reduction in C2Q15. The company expects the vast majority of that reduction to occur within the iPhone segment, which we believe is driven by disappointing sales of the iPhone 6s and some cannibalization by the unexpectedly popular iPhone SE, which is in short supply. Taking our C2Q16 iPhone ASP assumption of $620 and assuming that 95% of the $2bn reduction is iPhone, we calculate a 3mn hit to iPhone shipments in the June quarter vs. an estimated 1mn drag in the year ago period. Net-net, we expect a 2mn unit headwind which equates to a 4pt revenue growth headwind on a yoy basis from the planned channel inventory reduction in F3Q.

 

Installed base up 80% over the past 2 years, supports “7” refresh cycle in 2H

 

On this quarter’s earnings call, Apple disclosed additional information about the growth of its iPhone installed base as well as the upgrade rate relative to prior cycles. CEO Tim Cook said that the active iPhone installed base is up 80% vs. two years ago; note that Apple includes secondary market devices within its definition. In addition, the upgrade rate for the iPhone 6s is slightly higher than the iPhone 5s but lower than the particularly robust iPhone 6 cycle; this suggests that the yoy decline in the replacement rate we are seeing currently may be more due to difficult comps and a pull forward by the iPhone 6. We view these as positive indicators heading into the iPhone 7 cycle this fall, as we continue to expect a return to yoy unit growth driven largely by upgrades of the rapidly growing installed base. Recall that our survey of over 1,000 US consumers indicated that 44% of respondents intend to buy the iPhone 7 this fall which we view as a strong indicator of pent-up demand within the installed base. Please refer to our report, Reiterate CL-Buy as Apple enters upward estimate revision cycle dated April 12, 2016 for detailed discussion about our survey.

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