Dear Sceptics, Here’s How Apple Will Continue To Demolish Expectations

Tim Cook Apple

Apple delivered the greatest earnings report in history last night.

That’s not hyperbole. Apple earned $US18 billion in net income over the three month period of October to December 2014. That’s more than any other company has ever earned over a three month span.

Apple earned those mind-melting profits thanks mostly to the iPhone, which is an incredible business.

Apple sold 74.5 million iPhones, up 46% from the year prior. The iPhone generated $US51 billion in revenue, giving each iPhone an average selling price of $US687.

And yet, despite Apple’s incredible performance, there are plenty of people that think Apple has no shot at growing from here. Plenty of people think Apple had an explosion of iPhone upgraders buying the iPhone 6 and iPhone 6 Plus, and now it will either see sales level off, or even start to shrink.

Stuart Jeffrey at Nomura, for instance, said, “We still see a high likelihood that sales growth proves challenging as we end the calendar year, which we would expect to weigh on the stock’s earnings multiple.”

When you consider that the average Android phone is something like ~$US300 and dropping, it’s not crazy to think Apple’s iPhone business can’t continue doing what it’s doing.

However, we’re going on year 8 of the iPhone. At some point, people are going start believing that Apple can sell lots of phones for a long time, despite the relatively high prices.

Tim Cook, Apple’s CEO, did his best to explain to analysts why Apple can sustain its iPhone business on last night’s earnings report. It comes down to three main points:

  • Only a “fraction” of Apple’s iPhone user base has upgraded to the latest model of the iPhone. Tim Cook said it was a “low-teens” percentage of the iPhone user group. According to analyst Ben Bajarin, Apple has 400 million iPhone users. That means there are 340 million iPhone users due for an upgrade. That’s a lot of phones left for Apple to sell. Apple has incredible customer retention, so these people will upgrade.
  • There are a lot of people that still don’t have smartphones, and those people will buy iPhones. Tim Cook: “I would also point out that we had the highest number of customers new to iPhone last quarter than in any prior launch.”
  • There are a lot of people that own Android phones. Cook, again: “The current iPhone line up experienced the highest Android switcher rate in any of the last three launches in the three previous years.”

Put all of that together, and it’s pretty clear Apple has runway to continue growing the iPhone business.

Will Apple post another quarter where we see a 46% leap in iPhone unit sales? Probably not. At these levels, it’s going to be nearly impossible for that to happen. But, Apple can still grow the iPhone at solid rates for years to come.

Here, via Seeking Alpha, are Tim Cook’s full comments on why he believes the iPhone business will continue to be strong:

Sure Katy. It’s Tim. You can see from the March guidance that we’ve given, that we are incredibly bullish about iPhone going forward. We believe that it’s the best smartphone in the world. Our customers are telling us that. The market is telling us that. We’re doing well in virtually every corner of the world. And so we’re very bullish that it does have legs. I would point out that only a small fraction of the installed base has upgraded. And so there is a lot more people within the installed base. But I would also point out that we had the highest number of customers new to iPhone last quarter than in any prior launch. And also that the current iPhone line up experienced the highest Android switcher rate in any of the last three launches in the three previous years. And we didn’t look back to the other years. So I don’t know about those.

And so we see that we’re appealing to new customers, both new to smartphone and new to iPhone and people switching. We’re very bullish on the product and getting great feedback about the quality of the products we’re shipping. And so we’re very, very bullish. The emerging markets which has been a source to great questions over time, the growth was absolutely stunning, in Brazil and Mainland China more than doubling year-over-year which is 3x to 4x what those markets were doing according to IDC. And so we enter the quarter with quite a bit of momentum.

[Later an analyst asked for more colour on what per cent of the install base upgraded…]

…It’s a small fraction. It’s a number that’s in the mid-teens or barely in the teens. And so when I look at that I say that there is an enormous amount left. And given there are fair amount of Android units out there, there is also an enormous amount of Android customers that could switch. And I’d also remind you that there is a lot of people that have not yet bought a smartphone. And I know it doesn’t feel like that when you’re sitting in the United States, but from a worldwide point of view there’s still lots of them. And so I see all three of those groups there and I’m very excited about all of them, and serving all of them.

[Then an analyst asked about Android switchers…]

Bill, at this point, just shortly after the quarter, we don’t have all of our research in from all of the people that bought last quarter. But in the aggregate, as I’ve mentioned before, we saw more new customers to iPhone than we had ever seen before. And we had a higher rate of Android switchers than we had in the three previous launches. And it’s not that we had more in the fourth one, and I don’t what those numbers are, and whether it’s something we’re looking at. And so between the switchers and the people that are just new to smartphones and selected an iPhone, and our upgrades, which we’re very happy with, but represent a small fraction of our installed base, we feel really great about what’s in front of us.