Apple Earnings Only Worth a "C": iPhone Sales the Sole Bright Spot, Weak China Sales, and AI Yet to Push Supercycle

Apple has finally delivered its third-quarter results (officially the fourth fiscal quarter, ending September 28), though the results are not that promising. Sales and earnings both beat expectations, primarily driven by iPhone, while other product and service lines were fairly lackluster. The company's weak guidance and the continued weak China sales have sounded alarm bells.

The share fell nearly 2% in after-hours trading. Excluding the loss, the stock has jumped 18% YTD, with a market cap of $3.43 trillion.

Here are the results:

Revenue: $94.93 billion, up 6% y/y, surpassing the expected $94.6 billion.

Net Income: $14.7 billion, down 36% y/y, impacted by a one-time tax charge of $10.2 billion due to an EU ruling; Adjusted earnings per share were $1.64, up 12% y/y, beating the expected $1.60.

Gross Margin: 46.2%, slightly above the expected 46%.

iPhone revenue, which accounts for nearly half of Apple's revenue, posted $46.2 billion, up 6% y/y, beating the expected $45.5 billion. This includes one week of sales for the iPhone 16 series, which was officially launched on September 20, giving an early indication of the performance of AI-enhanced iPhones.

At least for now, management seems satisfied. CEO Tim Cook stated that iPhone 15 sales were stronger than last year's iPhone 14, and iPhone 16 was stronger than iPhone 15. He also expressed high expectations for the newly launched Apple Intelligence, which started rolling out this week as part of the iOS 18.1 update. "We're getting great feedback from customers and developers already, and a really early stat, which is only three days' worth of data: Users are adopting iOS 18.1 at twice the rate that they adopted 17.1 in the year-ago quarter," Cook said.

However, compared to the flagship iPhone, other Apple hardware fell short of expectations. Mac revenue posted $7.74 billion, up 2% y/y, below the expected $7.8 billion. Despite the sustained strength of new iPad Air/Pro models launched in May, overall iPad revenue increased 8% y/y to $6.95 billion but missed the expected $7.1 billion. Revenue from the wearables, home, and accessories division was $9.04 billion, down 3% y/y and below the expected $9.2 billion, considering Apple's outlook for the segment with the limited upgrades in the latest Apple Watch S10 and AirPods models seems bleak.

Apple's major growth engine, services, which includes App Store, Apple Music, and TV+ streaming platforms, is also slowing down. Service revenue posted $25 billion, up 12% y/y, down 2 percentage points from the previous quarter's growth rate, and missed the expected $25.3 billion. The company also stated that it expects service business growth to be similar to the past year's growth rate of 12.87%. Even with the introduction of new AI, strong iPhone sales, and a rebound in consumption, the boost to service performance remains limited, which is undoubtedly a significant negative for the market.

In a call with analysts, Apple stated that it expects sales in the December quarter to grow by low to mid-single digits. Analysts generally expect a growth rate of +7%. This suggests that the benefits from new products and AI are still modest.

Continued Weak Demand in China: What's the Problem?

Notably, among Apple's five major markets, China is the only region facing negative growth. For instance, revenue in the largest market, the Americas, posted $41.7 billion, up 4% y/y, and Europe was even stronger, with revenue up 11% y/y to $24.9 billion. However, revenue in Greater China was $15.0 billion, down slightly by 0.3% y/y. This may include the short-term difficulty of launching Apple Intelligence in China and the impact of consumers waiting for the Double 11 shopping season, indicating a more cautious overall approach. Continued observation is necessary to determine whether the sales slowdown in this region is merely a matter of timing or a sign of real demand obstacles. Additionally, Japan and other Asia-Pacific regions saw growth of 8% and 17%, respectively.

Overall, Apple's performance this time was mainly supported by iPhone sales. As AI features are introduced, whether they can further drive growth in iPhone, Mac, and iPad categories will be key areas of focus, potentially providing a much-needed boost to the slowing services sector. However, the company's current guidance remains less optimistic, especially with the persistent cooling in  China. Whether Apple can turn the tide remains to be seen.