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What's Happening to Apple’s Product Cycles?

By Motley Fool Staff – Sep 29, 2016 at 8:28AM

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Apple’s product cycles used to have a predictable cadence, but the Mac maker is now switching it up. The Motley Fool’s Dylan Lewis and Evan Niu talk about the implications for investors.

Apple (AAPL -0.34%) recently unveiled their iPhone 7 and 7 Plus, and despite some dismay around the headphone-less design, the company's stock has popped a whopping 10% on the news of record-breaking pre-order numbers.

In this segment from Industry Focus: Tech, Motley Fool analysts Dylan Lewis and Evan Niu discuss what Apple's growth trajectory might look like for the next few years (given the comps they're up against), how and why the company might have to change its design cycle timeline in the not-too-distant future, where the Watch 2 fits into all of this, and why Apple is going to eventually have to come up with a new naming scheme for the iPhone line.

A full transcript follows the video.

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This podcast was recorded on Sept. 16, 2016.

Dylan Lewis: This recent rise that we talked about actually pushes Apple above a 13 P/E on a trailing basis for the first time in a year.

Evan Niu: Ooh, so expensive! (laughs)

Lewis: Yeah, right? It's kind of insane. But looking at how all of this fits into where the business is going, last quarter, the company guided for revenue between $45.5 billion and $47.5 billion. And even if they dramatically beat that guidance, which, they've typically been in the high end of their guidance range or slightly above it, they will likely fall short of previous years' number for the third straight quarter. I believe last year ago quarter, the fourth fiscal quarter, they were around $51 billion, just to give you an idea of how different the guidance is there. It's tough to keep seeing this. The product is really successful. Customer satisfaction was really great. They just keep going up against these really tough comps. Eventually that's going to change, but don't expect that trajectory to be any different for the next couple quarters. I think that's one of the key things investors need to keep in mind here. You're going to probably see year-over-year declines for this quarter, next quarter, possibly even three quarters out.

Niu: I think there's a chance the iPhone 7 could, generally speaking regardless of the time... the timing for the year-over-year comps is always tricky, because it's always really dependent on when they launched the phone. In this case, they're launching the phone with two or three weeks left to the quarter. Last year, I think they had just a couple days. So, the launch timing really has a big impact on how much of that launch gets captured in which quarter. But, in general, I think there's a chance that the 7 could push the cycle up.

The sense is, iPhone unit sales have picked because they've been flat-ish, roughly, over the past year, year-over-year or whatever. But if you look, every two years, they basically pushed higher because of the cycle, this two-year design cycle of 5, 5S, 6, 6S, etc. So, the performance of the sales, at least for the past two major product cycles, they tend to go in tandem. Because if most people upgrade their phones every two years, and all the people who upgraded for the 6 are probably all going to upgrade for the 7, they had this pattern of going in pairs. Who knows if that actually plays out again this year, because the sales are so high that is hard to really grow. But I think there's a possibility, particularly with all the kinds of indications that we're seeing. But I wouldn't bet on it. I'm just saying, it's like a curveball, it's possible.

Lewis: We've talked in the past about the idea of two-year comps being a bit more relevant for Apple, because of the update cycle that they're on. I think, as you talked about before, their refreshes on the product become more incremental and less major step changes, then I start to look at them more on a year-over-year basis. To your point about releases, another important thing to remember here is, all the numbers that Apple will be reporting for fiscal Q4, calendar Q3, only two weeks of that period will have the iPhone 7 available. It will be a part of those numbers, but it will not be a major contributor. You're going to really want to look at fiscal Q1, calendar Q4, for what it's going to be doing for the financial statements. I'm sure we're going to get some commentary in the company call come fiscal Q4. But that's something to keep in mind.

Niu: And it's weird, because this is the first time they've ever pushed a three-year design cycle. It'll be really interesting to see how that changes the performance. They've never done a three-year design cycle before. And it's also a testament to smartphones getting more mature. It's kind of like laptops. They redesign laptops every four to five years, but they would redesign their phones every two years. So now you're seeing, they feel comfortable that they can push that limit on the design side. But then, the real question is, what happens next year? Because everyone is expecting a new design next year, maybe another display, maybe no home button, maybe curb display, whatever. Then, it just throws everything out of whack, the fact that they're changing the timing of these cycles. It's going to be cool to see what happens going forward. And plus, what are they going to call it? They can't call it the 7S if they change the design altogether.

Lewis: Eventually they're going to have to ditch that naming convention, one way or another.

Niu: I've been saying they should ditch that thing for years. This is the iPhone 7. It's the 10th iPhone. And what, next year it'll be the iPhone 8, the 11th iPhone? It just makes no sense.

Lewis: Yeah. I think, to bring it back around, and what to watch for here, if the product incremental upgrades that we talked about, some of their performance changes are visible enough to people that maybe currently hold an iPhone 6, or the offers from these wireless carriers look compelling enough, I think you could see some really great numbers for fiscal Q1, which will be calendar Q4. But you won't get a report on that for quite a bit. Be wary of that, and know that any really big enthusiasm is going to come through more on the company's call than in the numbers that the company reports next quarter.

Anything else on this? That's kind of investing take away. Obviously, everything that they delivered here was what we'd been expecting from pre-launch leaks and rumors.

Niu: Yeah. Everything pretty much came in right on target with expectations, as far as the product specs and things like that. I think the Watch 2 looks OK, it's kind of the same thing, Watch 2 looks like what they should have done with the first one. I don't think many people are going to upgrade from the Watch 1 to the Watch 2. It just doesn't seem very compelling. But maybe they get more first-time adopters that were on the fence about Watch 1 and didn't do it, but now Watch 2 is more compelling, a stronger product, so maybe the people that were on the fence will jump in and go ahead and be a first-time buyer for the smartwatch. And, of course, once they do that, they're on this upgrade track, and they're going to eventually upgrade, however long, who knows.

Lewis: Yeah, you have the chance to win over those people who don't want to own a first-generation device with the Watch, basically.

Niu: Right. I think the Watch 2 does look compelling in that sense. Of course, there's no detailed results to compare to, because Apple won't give them to us. But just generally, I think, products just get better over time. Next month, they're supposed to have these new Macbook Pros, which might reinvigorate the Mac lineup. That lineup has been there for four years. So, coming out with a new thing there could really juice the Mac performance for the next few years.

Dylan Lewis owns shares of Apple. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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