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Apple Earnings Preview: Is It Really Going to Be That Bad?

By Andrés Cardenal - Jan 20, 2016 at 9:31PM

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The bad news is that growth is expected to slow down, but the good news is that Apple stock looks remarkably cheap going into earnings.

Image source: Apple.

Investors in Apple (AAPL 0.95%) stock are going through considerable pain lately. Shares of the tech giant are down by more than 25% from their highs from the past year due to increasing concerns about slowing iPhone demand. The company is scheduled to report earnings on Tuesday, Jan. 26, and the coming earnings report from Apple will be closely scrutinized in order to tell if things are really that bad or if investors are overreacting to the bad news in the short term.

Reasons for negativity
The iPhone brings in nearly 66% of Apple's total revenue, so sales in this segment are of utmost importance for the company. Different news outlets and Wall Street firms have recently reported that Apple has reduced component shipment orders for the iPhone 6s and iPhone 6s Plus models due to lower-than-anticipated demand and rising inventory levels in different markets.

Nikkei reported on Jan. 6 that Apple cut production plans for the latest iPhone models by 30% versus its original plans for the January to March quarter. On a similar note, most Wall Street analysts are expecting a small year-over-year decline in iPhone sales for the quarter ended in December. 

Several Apple suppliers have aggravated the fears lately. Qorvo (QRVO -1.72%) makes radio frequency solutions for mobile, infrastructure, defense, and aerospace applications. Nearly 80% of Qorvo's total sales come from smartphones, and Apple accounts for a huge 50% of total revenue. Unfortunately, Qorvo reduced its sales guidance for the third quarter of fiscal 2016 from a previous range of $720 million to $730 million down to $620 million. According to Qorvo, most of this reduction in guidance is due to weaker-than-expected demand in the mobile products segment. 

Cirrus Logic (CRUS -0.55%) produces audio integrated circuits, and Apple is its main customer by a wide margin. Cirrus Logic also reduced its sales guidance for the coming quarter, from $370 million to $400 million down to $347 million, which management attributed to weak demand in portable audio products. Cirrus Logic said in the press release that this weakness escalated during the last few weeks of December, and this is in line with other reports about slowing production orders from Apple over that period.  

Electronics retailer Best Buy (BBY -3.08%) has announced disappointing sales during the holiday period, which management attributed mostly to weakness in smartphones. According to Best Buy: "The domestic decline was primarily driven by the mobile phone category, which was softer than both our expectations and the prior year." 

Best Buy sells smartphones from Apple as well as many other industry players, so it's hard to tell if this falling demand is mainly about the iPhone in particular or the industry in general. Still, when interpreted in the context of all the negativity surrounding Apple sales forecasts lately, the sales report from Best Buy is hardly a positive for Apple. 

The good news about the bad news
The smartphone industry is maturing, and Apple will be facing tough year-over-year comparisons due to booming demand for the iPhone 6 and iPhone 6 Plus in previous quarters. On the macroeconomic front, economic weakness in emerging markets and an appreciating U.S. dollar versus other global currencies could put additional pressure on the company's revenue. 

But the good news is that a possible slowdown in iPhone sales is already incorporated into expectations to a good degree. Apple stock trades at a forward price-to-earning ratio around 9, a big discount versus the average company in the S&P 500 index with a ratio in the neighborhood of 17. This is clearly a remarkably cheap valuation for such a profitable business producing massive amounts of cash flow

Investors tend to put too much attention on short-term news versus a company's long-term fundamental quality, and everyone is expecting decelerating iPhone sales at this stage. If the slowdown turns out to be less drastic than feared, and/or if Apple can compensate for this deceleration with growing sales of other products and services in the mid term, then the stock could offer big upside potential from currently depressed price levels.

Andrés Cardenal owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends Cirrus Logic. 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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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
$174.67 (0.95%) $1.64
Cirrus Logic, Inc. Stock Quote
Cirrus Logic, Inc.
$87.53 (-0.55%) $0.48
Best Buy Co., Inc. Stock Quote
Best Buy Co., Inc.
$82.33 (-3.08%) $-2.62
Qorvo, Inc. Stock Quote
Qorvo, Inc.
$106.05 (-1.72%) $-1.86

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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