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Apple Stock Earnings: Will the iPad Be a Drag?

iPad Air. Source: Apple.

In less than two weeks, Apple (NASDAQ: AAPL  ) will release fiscal third-quarter results. The summer months usually see a slowdown in demand, especially as consumers begin delaying purchases in anticipation of upgraded products that are usually launched in the fall.

iPad unit sales in the March quarter were a little soft. Fortunately, the overwhelming strength of the iPhone more than offset that weakness. Still, it was only the second time that Apple has ever reported a year-over-year decline in iPad unit sales.

Source: SEC filings. Calendar quarters shown.

Can the iPad stage a comeback or will it be a drag?

A broader slowdown
There are other signs that growth in the tablet market starting to decelerate, which could also point to lackluster iPad sales in the June quarter. Samsung (NASDAQOTH: SSNLF  ) recently provided earnings guidance. While there are some possible positive implications for Apple overall, Samsung took note of "weak overall market demand" for tablets. Upgrade cycles are longer than in the smartphone market since carriers generally don't subsidize tablet purchases (though not for a lack of trying in the past).

IDC pegged first-quarter tablet growth at an anemic 4%. NPD DisplaySearch says that global tablet volumes declined in the second quarter for the first time ever. On the other hand, Gartner still thinks the long-term outlook is rosy; Gartner still expects tablet volumes to overtake PC volumes by the end of next year.

It's worth remembering that the iPad is Apple's most successful foray into a new product category to date, easily outpacing iPod and iPhone adoption. After blistering growth for years, perhaps demand is just taking a breather before resuming its upward course.

Source: SEC filings.

There are also other factors at play. As consumer preference continues to shift toward larger phones, there is some inevitable cannibalization of small-sized tablets. It's true that Apple never frets about cannibalization (it makes more money on iPhones anyway), but Tim Cook is also one of the most vocal proponents of tablet adoption. Broader cannibalization of small-sized tablets still undermines the overall tablet market.

An uneventful upgrade
Apple did finally retire the iPad 2 in March, replacing it with the iPad with Retina display at the same $399 price point. However, this upgrade likely won't drive a meaningful uptick in the June quarter. Instead, it was possibly a move to streamline both Apple's cost structure and platform.

Doing so made Retina displays ubiquitous throughout the 9.7-inch lineup, so Apple could fully move away from non-Retina displays for the larger models. It no longer needs to purchase non-Retina 9.7-inch panels, which in turn implies greater negotiating leverage when buying incrementally greater volumes of Retina 9.7-inch panels.

Additionally, iOS developers should continue shifting toward Retina-only resolutions for apps. The only remnant of non-Retina resolution is within the first-generation iPad Mini. Apple could finalize this transition if it retires the first-generation iPad Mini later this year.

Other factors
Unfortunately, historical data on seasonal trends isn't very helpful. Apple used to introduce new iPad models in the spring, leading to a boost in sales throughout the summer. In 2012, Apple launched new iPads twice as it shifted iPad launches to the fall. But if 2014 turns out anything like 2013 (the only comparable year in terms of product cycle timing), there should be a sequential drop in iPad sales heading into the second quarter.

Apple recognizes sales based in channel sell-in. The March quarter's softness was largely related to changes in channel inventory. The prior year, Apple had increased channel inventory, but this year Apple decreased channel inventory. Sell-through was fairly comparable, down just 3%. Apple entered the June quarter with 5.1 million units in channel inventory. With new iPads on the horizon, it's very unlikely that Apple would be increasing channel inventory right about now. Assuming no major changes in channel inventory, Apple will face an easier sequential comparison with the March quarter.

There probably aren't a lot of reasons to expect much iPad upside this quarter. Hopefully, the iPhone can carry the show.

Will the iWatch eventually be the star of the show?
Apple recently recruited a secret-development "dream team" to guarantee that its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are even claiming that its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts that 485 million of these devices will be sold per year. But one small company makes this gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and to see Apple's newest smart gizmo, just click here!

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Evan Niu

Evan is a Senior Technology Specialist at The Motley Fool. He was previously a Senior Trading Specialist at a major discount broker. Evan graduated from the University of Texas at Austin, and is a CFA charterholder.

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