iPhone Concerns Surrounding Apple Inc. Stock Are Very Real

Vince Martin

Updated Sat, Apr 28, 2018, 6:00 AM

When it comes to Apple Inc. (NASDAQ:AAPL) stock, there’s one important thing to keep in mind. AAPL stock is heavily dependent on the iPhone. If an investor asks, “Should I buy Apple stock?” the decision as to whether Apple stock is a buy or sell comes down to that investor’s belief in the long-term potential of that key product.

I’ve been skeptical on that front for some time, and for the most part, the market has disagreed. Even with iPhone concerns leading to choppy trading in AAPL over the past few months, the stock still has risen a healthy 26% over the past year.

But those concerns are starting to mount, with AAPL selling off by nearly 3% on Thursday after a key supplier delivered a disappointing earnings report. And we’re getting to a point where the answer to “Should I buy Apple stock?” is becoming an emphatic “No.”

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AAPL no doubt is cheap, trading at a basically zero-growth 11-12x earnings multiple, backing out its hefty cash pile. The company will distribute a ton of cash to shareholders over the next few years, as I pointed out earlier this year. And the iPhone remains a transformative, and highly sought-after, product.

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But if iPhone demand is slowing, Apple still doesn’t have enough elsewhere to pick up the slack. And with a steady drumbeat of negative news surrounding the iPhone X, there’s reason to think that Apple earnings — and maybe even Apple stock — have peaked.

iPhone Problems

The big news for AAPL on Thursday was that Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) posted a disappointing earnings report. Taiwan Semi actually manufactures the chips designed by other companies, among them Advanced Micro Devices, Inc. (NASDAQ:AMD), Intel Corporation (NASDAQ:INTC) and Nvidia Corporation (NASDAQ:NVDA).

The problem for Apple is that Taiwan Semi’s billion-dollar revenue miss was driven by weakness in the smartphone industry, which means weakness for the iPhone. TSM stock fell nearly 6% on the news, with AAPL down 2.8% in sympathy.

At the moment, the drop in Apple stock doesn’t appear to be an overreaction. Apple accounts for nearly 20% of Taiwan Semi’s revenue. It is exceedingly difficult to see TSM’s miss as anything but bad news for iPhone X demand as calendar 2018 rolls on.

At least two analysts have lowered estimates for iPhone X unit sales as a result, and those projections already had been cut. And combined with similarly negative news from other suppliers, the lower estimates appear justified.

Add to that continuing weakness in China, and the risk to Apple stock is clear. If new models don’t drive the same level of optimism — and pricing — it’s tough for iPhone revenue to grow. And if iPhone revenue doesn’t grow, Apple earnings likely don’t either.

The Importance of the iPhone to AAPL

It’s a sign of just what an amazing product the iPhone has been that Apple’s other products, as successful as they are, really aren’t capable of moving Apple stock.

In fiscal 2017, per the Apple 10-K, the iPhone drove 62% of the company’s revenue. The contribution to profits likely is higher. The company’s goal of reaching $50 billion in services? It still would mean that category would drive less than one-fourth of total revenue.

HomePod sales are disappointing, but even if they strengthen, they have little chance of generating more than 5% of total sales. Apple TV, Apple Watch and Beats products are only part of an “Other Products” category that combined drove barely 1/20 of fiscal 2017 revenue.

This is a company valued at over $900 billion. What would be a massive success elsewhere — like, say, Apple Music, whose growth continues to impress — barely moves the needle in terms of valuation. Apple, as I’ve written before, is all about the iPhone. And that has to be considered a concern in the wake of increasingly disappointing news surrounding that product.

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AAPL bulls could argue that even with that risk, Apple stock remains a buy. After all, a 10-11x earnings multiple ex-cash suggests basically zero, if not modestly negative, growth going forward.

But that looks about right. iPhone replacement cycles are going to extend, as the need to upgrade decreases as functionality improves. At some point in the future, the smartphone will simply be commoditized, leaving Apple to fight for a small base of high-end customers. If iPhone revenue growth already is decelerating, a long-term outlook suggests the trend will get worse, not better.

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There’s a reason Apple stock looks cheap and has for years now. It’s not because the market doesn’t understand the most valuable company in the world. It’s because it does. And the bad news surrounding the iPhone very well may start to be priced in over the coming months.