Apple (NASDAQ:AAPL) reported a huge earnings beat this week, with EPS coming in 14% ahead of the average analyst estimate. The iPhone was by far the biggest driver of Apple's strong performance.
Fortunately for Apple shareholders, iPhone sales and earnings growth is likely to continue at a strong pace in the next few years. Apple is attracting plenty of new users, and a larger-screened iPhone 6 should accelerate that trend, while also driving a major replacement cycle.
Most importantly, Apple's iPhone product roadmap positions it well for strong growth in China in the next few years. Larger-screened phones should help Apple gain share from Android among wealthy Chinese consumers. Meanwhile, as lower-cost phones become available through top carrier China Mobile (NYSE:CHL), sales will probably surge.
The iPhone is crushing sales expectations
Last quarter, Apple sold 43.7 million iPhones, up 17% year-over-year. This set a new March-quarter record. iPhone revenue rose 14% or more than $3.1 billion, which accounted for more than 100% of Apple's total revenue growth last quarter.
Apple's iPhone sales total came in way ahead of what analysts expected. In a survey of 32 analysts (20 Wall Street professionals and 12 "independents") conducted by Philip Elmer-DeWitt of Fortune, the average iPhone sales estimate was 38.2 million units. The highest estimate was 42.5 million: still more than 1 million units short of Apple's actual sales tally.
Apple executives explained on the earnings call that the iPhone strength is broad-based. Apple fans are continuing to buy the new iPhone 5s in droves (it now accounts for more than 20% of all iPhone usage), but the iPhone 5c and the older iPhone 4S are also selling well. Apple estimated that more than 50% of iPhone activations in the last 6 months came from new iPhone users.
iPhone sales in China hit a new quarterly record, driven in part by the addition of China Mobile as an iPhone carrier partner. However, that was not the whole story. Strong sales of the cheaper iPhone 4S -- which is not available through China Mobile -- also contributed in a big way.
The China opportunity is growing
Most signs are pointing toward Apple releasing a new iPhone (presumably the iPhone 6) with a 4.7" or 4.8" screen later this year. Apple may also add a "phablet" with an even bigger screen within the next year. Larger screen sizes have been popular in China, and so Apple could significantly improve its competitive position there with a bigger iPhone.
Furthermore, Apple clearly saw some sales lift last quarter from its recent agreement with China Mobile, which is the world's largest wireless carrier. However, the short-term sales lift pales in comparison to the long-term opportunity at China Mobile.
First, Apple's iPhone is one of the first devices to be promoted for China Mobile's new LTE service. China Mobile is in the midst of expanding LTE from just a handful of key cities at the beginning of 2014 to (hopefully) hundreds of cities by the end of the year. As LTE service improves, Apple's sales through China Mobile should rise.
Second, most Chinese consumers cannot afford to buy a top-of-the line iPhone, which can cost the equivalent of nearly $1000. That's why Apple has seen such strong sales of the older iPhone 4S in China and other developing markets. However, the iPhone 4S does not have LTE and it doesn't work with China Mobile's 3G network either.
When the next iPhone comes out, Apple will probably stick to its policy of slashing the price on its older models. That will move the LTE-equipped iPhone 5c to a more affordable price point at China Mobile. (Apple took a step down this road last month by putting an 8GB iPhone 5c on sale in China at roughly 10% off the price of the 16GB version.) This will make Apple competitive in a huge market segment that it's not competing in today.
Foolish bottom line
Today, Apple is fighting in the smartphone market with one arm tied behind its back. It doesn't have a big-screen iPhone yet, let alone a phablet. It can't sell its current entry-level phone at China Mobile -- the world's largest carrier -- because of compatibility issues. Lastly, the China Mobile LTE rollout, which is one of the biggest long-term iPhone growth catalysts, is still in its early stages.
In spite of this, Apple's iPhone posted double-digit growth for the 3rd time in the last 4 quarters. With Apple set to fix some of its weak points in the smartphone market later this year and into 2015, the iPhone is positioned for even stronger growth going forward. This momentum should carry Apple stock higher as well.