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1 Significant iPhone Risk Facing Apple Inc. in Fiscal Year 2016

By Ashraf Eassa – Jan 11, 2016 at 9:30AM

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Average selling prices could erode this year, potentially driving further downside for iPhone-related revenue in FY2016.

At this point, it is well-known that Apple (AAPL -3.00%) is facing significant challenges with this iPhone cycle. Multiple negative data points from many major Apple suppliers (two suppliers even went so far as to negatively pre-announce) suggest that Apple has cut -- perhaps dramatically -- its iPhone build plans for the next several quarters.

Interestingly, analysts with boutique research firm BlueFin (via Barron's) have a fairly novel explanation of what might actually be going on with respect to iPhone. This hypothesis, if true, could potentially point to the beginning of a negative long-term trend for Apple.

iPhone 6s/6s Plus not doing that well, but iPhone 6 still holding up?
The analysts claim that the "30% reduction" with respect to iPhone builds that has been circulating in the press is "specific to the 6s/6s+ models," and doesn't represent the decline in total iPhone builds.

Indeed, the analysts say that production of the older iPhone 6/6 Plus models, as well as the iPhone 5s, has, surprisingly enough, increased over the last month.

Ultimately, the BlueFin analysts say that Apple "misfired" with respect to product mix.

A big year-over-year decline as mix shifts down?
If BlueFin's estimates are correct, then Apple will ship around 51 million iPhone units in the March quarter this year, down about 10 million units (or around 16% year over year). This reduction, the analysts say, is due to the fact that Apple is trying to "draw down channel inventories."

It would seem to me, then, that Apple overshipped during the first calendar quarter relative to demand (leading to a swelling of channel inventory), which is probably why the company didn't wind up issuing a revenue warning for its first calendar quarter.

However, the more alarming part of this note is that demand for the iPhone 6/6 Plus -- which are older and sell for less -- seems to be holding up fairly well.

Worse mix could mean lower average selling prices
In a previous analysis contemplating the potential year-over-year iPhone-related revenue decline Apple may face in fiscal 2016, I estimated that revenue will decline about in line with unit shipments as average selling prices could be flat.

However, it would seem now that a reasonable assumption would be to expect iPhone average selling prices to potentially contract during Apple's fiscal year 2016.

Average selling price declines atop of what looks to be a unit decline of between 8% and 12% year over year might mean iPhone revenue declines solidly in the double digits this year.

Why is iPhone 6s/6s Plus demand so weak as iPhone 6/6 Plus demand holds?
In the last two iPhone cycles, Apple has seen much stronger demand for its latest premium flagships than for its previous-generation/lower-end models. However, this year's lower-end models are quite unique compared to those seen in prior cycles.

During the iPhone 5s cycle, Apple stopped production of the older-generation iPhone 5 and in its place sold the plastic-shelled iPhone 5c. Then, during the iPhone 6/6 Plus cycle, the "cheaper" iPhones were the 4-inch 5s and 5c devices.

However, during this cycle, things are much different. The "value" options are now the iPhone 6/6 Plus. They don't have the features/performance that the newer iPhone 6s/6s Plus have, but they look very similar, are actually thinner and lighter, and are quite a bit cheaper for comparable storage options.

Frankly, for the first time in several generations, Apple's cheaper phones are still quite excellent choices, especially for those who want to save money.

The iPhone 6s/6s Plus issues are clear
In hindsight, it's not hard to see why iPhone 6s/6s Plus demand isn't proving to be as robust as hoped. The iPhone 6s/6s Plus isn't compelling enough for many iPhone 6/6 Plus buyers to upgrade (while the 6/6 Plus were compelling options for buyers of even the 5s in the year prior). On top of that, for buyers with older iPhones -- say, 5s and older -- the iPhone 6/6 Plus at cheaper price points are perfectly good.

Looking ahead to iPhone 7
It will be interesting to see what Apple keeps around as its "cheaper" options once the iPhone 7 launches. If it keeps the iPhone 6/6 Plus at their current price points and replaces the 6s/6s Plus with the iPhone 7/7 Plus, then Apple risks having less competitive products at those price points (where its competition is innovating quite fiercely).

If it pushes the 6s/6s Plus down, then Apple faces the same risk of seeing again what appears to be happening this year. What will work in Apple's favor, though, is that the iPhone 7/7 Plus should bring all-new industrial designs as well as internal upgrades.

Another factor is that, if we assume people upgrade their phones every two years or so, the people who bought the iPhone 6/6 Plus could be preparing to upgrade again. Those folks may choose the iPhone 6s/6s Plus if it's cheaper, but I'd imagine that those customers would be more interested in the 7.

We'll just have to see how it all plays out. Unfortunately for Apple shareholders, I don't think things have the potential to get very "interesting" until the iPhone 7 launches, which is still a good eight to nine months away. 

Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. Try any of our Foolish newsletter services free for 30 days. 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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