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3 Reasons Why Apple's CEO Is Not Worried About Falling iPhone Sales

By Andrés Cardenal - May 20, 2016 at 9:03AM

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Renewal sales, customers switching away from Android, and growing smartphone penetration could drive sustained growth for the iPhone.

Apple CEO Tim Cook. Image source: Apple.

Apple (AAPL 1.62%) stock is under considerable selling pressure lately. Shares of the tech juggernaut are down by more than 28% in the last year due to falling revenue in the critical iPhone segment. However, CEO Tim Cook believes the decline in iPhone sales is only a short-term problem.

The big question

Nearly 65% of total Apple revenue comes from the iPhone segment, so the product is vital in terms of overall financial performance. Apple registered a 16% decline in iPhone unit sales during the quarter ended in March, and total company-level revenue fell 13% versus the same quarter in 2015.

But that's old news for investors at this stage. The big question to consider is whether the decline is only temporary, or if Apple is on a long-term decline due to languishing iPhone demand in the years ahead. 

Apple CEO Tim Cook is an interested party in this discussion, so investors need to take some distance when analyzing his point of view. Nevertheless, Mr. Cook makes a strong case that the iPhone will continue growing in the future. Here are his own words, from Apple's last earnings conference call:

iPhone sales come from three sources: Customers who upgrade from previous iPhone models, customers who switch from Android and other operating systems, and customers who purchase a smartphone for the first time. As we look at each of these three sources of iPhone sales, we see a business that is healthy and strong.

Here are three reasons Cook says we shouldn't lose faith in the iPhone.

1. Renewals

The iPhone 6 was an explosive success for Apple in 2015. Many customers were eagerly waiting for a new iPhone with a larger screen, so sales skyrocketed. The iPhone 6s is not a game-changer compared to previous models, and this is making comparisons remarkably challenging in 2016.

The company sold 61.2 million devices during the quarter ended in March of 2015, a huge increase of 40% versus the same quarter in 2014. Unit sales during the quarter ended in March 2016 amounted to almost 51.2 million -- down 16% from the same quarter in 2015 but up by 17% versus 2014 levels.

This is important because it indicates that the decline in iPhone sales this year could be mostly due to tough comparisons against 2015 levels. Besides, Apple customers are remarkably loyal to the brand, and a gargantuan installed based bodes well in terms of renewals going forward.

According to Tim Cook:

From an upgrade perspective, during the first half of this year, the upgrade rate for the iPhone 6s cycle has been slightly higher than what we experienced in the iPhone 5s cycle two years ago, but it is lower than the accelerated upgrade rate we saw with iPhone 6, which, as you know, was a big contributor to our phenomenal revenue growth a year ago. Most importantly, our customers are incredibly loyal. A recent Kantar survey of U.S. smartphone purchasers indicated a 95% iPhone loyalty rate, the highest ever measured for any smart phone.

2. Android defectors

According to IDC numbers, Apple has a global market share of 15.2%, while a huge 82.6% of all smartphones around the world work with Android. This means that, even if overall industry growth is slowing down, Apple still has a lot of room to steal customers away from the competition. Tim Cook said in the last conference call that Apple is attracting record numbers of switchers from Android and other platforms, and this could be a strong growth-driver going forward.

We continued to see a very high level of customers switching to iPhone from Android and other operating systems. In fact, we added more switchers from Android and other platforms in the first half of this year than any other six-month period ever. 

3. Growing smartphone penetration

The smartphone market in the U.S. and other developed countries is highly saturated, but things are remarkably different in emerging markets, where smartphone penetration levels are still quite low. Income levels in many of these countries are also much lower, so it's hard to tell what levels of market share Apple can obtain in these markets over the middle term. However, that's no reason to discount the many growth opportunities abroad.

Apple has recently launched its new iPhone SE model, which sells for a comparatively low starting price of $399 versus a much higher starting price of $649 for the iPhone 6s. The iPhone SE seems tailor-made for capitalizing on growing smartphone demand in emerging markets.

According to Cook, increasing smartphone penetration should generate considerable opportunities for expansion in key emerging markets such as India.

With only 42% smartphone penetration of the global handset market today, iPhone is still attracting millions of first-time smartphone buyers each quarter, especially from emerging markets. For example, in India, our iPhone sales were up 56% from a year ago.

Only time will tell for certain whether Mr. Cook is right or wrong about growth prospects in the iPhone segment. However, between first-time smartphone buyers, customers switching away from other platforms, and renewal sales to current iPhone users, it looks like Apple's iconic product still has room for growth.

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