• Revenue grew 3% yoy to a record high US$78.3 bn
• Forex headwinds weaken guidance for next quarter
• Positive and negative risks with Trump administration
• Downgrade to “Neutral” from “ACCUMULATE” rating and higher TP of US$129.58 (previously US$125.81)

Results at a glance:

Source: Company, Phillip Securities Research (Singapore)

• Record high revenue for the quarter. AAPL reported 1Q17 revenue of US$78.4 bn, beating our revenue estimates of US$76.5 bn. This was even above AAPL’s upper range of guidance, which was between US$76 bn to US$78 bn. Revenue wise, this was a record high for AAPL, and can be attributed to better than expected iPhone results. The iPhone 7 and 7 plus were received favourably by consumers and iPhone sales were helped by the missteps of Samsung and the issues with its Note 7. Overall, AAPL ended up selling less units of iPhones than we had expected, 78.2 mn units vs our estimates of 82.4 mn units, but they managed to achieve a much higher ASP than we had expected, about US$694 vs estimate of US$650. We attribute this increase in ASP to the popularity of the 7 Plus as well as more consumers picking the higher storage capacity iPhones, which carry a higher selling price. However, despite the higher than expected revenue, cost of revenue ended higher than we expected, resulting in a lower EPS than we had estimated. EPS was US$3.38 vs our estimates of US$3.46, falling short of our estimates by US$0.08. Gross margins were 38.5% compared to 40.1% yoy, but within the range that AAPL had guided previously.

• Services grew by 18%. Service revenue came in at about US$7.17 bn, which was below with our estimates of US$7.39 bn. This represented an 18% increase yoy and the 5^th consecutive quarter of double digit growth for the services segment and a new all-time high for revenue. However, it is also the slowest growth that Services has had since services started to grow by double digits every quarter. Services are still growing at an impressive rate, but it will have to grow to a much larger extent than where it currently is to significantly impact AAPL’s revenue. As such, we remain cautiously optimistic about Services still, but will take note if this is the start of slowing Services growth.

• iPad Sales were down. iPad sales continued its trend down, falling 22% yoy. While not a really a significant contributor to AAPL’s revenue, this fall in sales is worrying to AAPL’s strategy to keep consumers within their ecosystem. Tim Cook attributed this to AAPL under calling the number of iPads in demand and therefore having a shortage issue, and claims that there are iPad related pipelines that he remains optimistic about.

• Mac and Apple Watch hit record sales. Revenue for Mac and Apple watch also hit their highest numbers ever, with AAPL citing strong demand over the holiday season. Mac hit US$7.24 bn in revenue on the back of the new MacBook Touch. AAPL cited that most of the Mac customers were first time buyers and that supply was constrained for the quarter.

AAPL guidance for 1QFY17:

• Revenue between $51.5 billion and $53.5 billion
• Gross margin between 38% and 39%
• Operating expenses between US$6.5 bn and US$6.6 bn
• Other income/(expense) of US$400 mn
• Tax rate of 26%

Investment Actions

AAPL has surged to US$128.79 since the earnings was released, up 6.13%. The share price has overtaken our previous target price of US$125.81, up 8.9% above the last close since our previous update was given. While AAPL did have a fantastic quarter, their guidance for the next quarter was weaker than expected. Slowing growth in China, with revenue down 12% yoy, in their best quarter ever is worrying, considering that Greater China is where the most growth opportunities are. Furthermore, the strong US dollar is also an obstacle to AAPL as a majority of their revenue is earned overseas. The Forex headwinds was a partial factor in AAPL giving a weaker guidance for the next quarter, citing about a US$1.2 bn Forex headwind. Politically, AAPL is also subject to both positive and negative risk as well with the Trump administration. On the positive side, if Trump goes through with a revision on the tax code with regards to repatriating funds from overseas, AAPL will be in for a windfall, given their huge cash hoard. However, if Trump were to start a trade war with China, and cause China to retaliate against American made products, AAPL’s efforts in China, which account for 20% of their revenue, will face even greater impediments. Given the surge in price, the headwinds and the risks, both positive and negative, we have changed our call on AAPL to a “Neutral” with an increased target price of US$129.58. We believe that AAPL’s current price is more or less fair value for the stock. AAPL did hit a record quarter and while the next quarter is guided lower than expected, Forex headwinds is not as much a concern to us over the long term. As such, we have raised our target price to accommodate the better than expected ASP for the iPhone 7. We remain cautiously optimistic about AAPL in the long run, but feel the stock is at fair value at current valuations.