Despite its four other multi-billion dollar businesses, tech giant Apple (NASDAQ:AAPL) still lives and dies by the iPhone.
As a device that evolves in cycles, the ebb and flow of iPhone sales have a disproportionate effect of sales and profit growth of the world's largest public company. This dynamic understandably elicits its fair share of study and discussion among the analyst community.
Recently, one well-respected research firm lowered its price target for Apple's shares citing reasons I'll discuss below. More importantly, the analysis also overlooks a coming catalyst for Apple shares -- the iPhone 7.
The best kind of bad news
As the headline read in The Wall Street Journal, "People Aren't Upgrading Smartphones as Quickly and That Is Bad for Apple." The title referred to a recent note from sell-side research firm BTIG, whose analysis I typically find sophisticated and well reasoned. Last week, BTIG lowered its 12-month price target for Apple stock, but the seemingly negative headline fails to tell the entire storyline.
What's missing is BTIG also maintained its Buy rating for Apple shares, and its new one-year price target for Apple stock of $130 still sits 19% above Apple's current stock price of $109.02 as of the close of trading on Monday. Read this way, the news certainly doesn't seem especially negative, though BTIG does cite a few important potential developments that could affect Apple in the coming months.
Specifically, BTIG cites a potential lengthening of the iPhone upgrade cycle and the possible competitive threat of Samsung's (OTC:SSNLF) new Galaxy S7 flagship handset as risks that could weigh on Apple's financial performance. Parsing reports from the four main U.S. telecom operators and its own research, BTIG makes a strong argument that U.S. smartphone upgrade cycles are indeed lengthening, a trend that could adversely impact carriers and handset OEMs like Apple and Samsung.
All told, BTIG now believes sales of smartphones by the four largest U.S. carriers will decline by 3.7% in 2016 before returning to grow 4% in 2017. Worse yet for Apple, BTIG also notes that its conversations with various industry players indicate Samsung's Galaxy S7 is also proving surprisingly popular. Combined, BTIG sees Apple's sales declining slightly in its current fiscal year. However, it seems to me that this analysis also overlooks one very important wild card.
Barring an unimaginable shift in strategy, Apple will revamp the form factor for the iPhone 7 later this year. Importantly, Apple's fiscal year runs one quarter ahead of the regular calendar year, meaning the holiday quarter is the first quarter of Apple's fiscal year. Seen this way, the sales effect of the iPhone 7 should appear in Apple's FY 2017, which BTIG agrees will return to growth for the Mac maker. However, this fails to account for the market's own possible attempts to anticipate this coming growth.
Earlier this year, I published a piece examining this specific dynamic, discussing the "ideal" time to buy Apple's shares in the face of what many analysts expected to be soft earnings reports early in the year for Apple. Some brief research uncovered that Apple's shares have historically outperformed the broad market by roughly 25% in the six-month window prior to each of Apple's past three form factor upgrades.
Despite the small sample size, it seems the market anticipates the coming growth from a new iPhone cycle before it actually begins. This means that despite BTIG's very plausible projections, Apple's stock could well move before iPhone cycle growth manifests itself in the company's financials. As such, it seems the potential negative effect of the slowing upgrade cycle could be more than offset by investors bidding up Apple stock in advance of the next iPhone. Again this isn't a given course of action, but it certainly seems plausible given what we know about Apple's typical product and financial cycles.