“Apple’s press conference at 18:00 (BST) today is the hot ticket for investors. The latest iteration of the iPhone is rightly being focussed on in the short-term and the market will give its verdict on the new devices on offer.

It’s the biggest and most important regeneration since the iPhone 6 refresh. Whilst there have been a lot of leakages there could yet be one or two surprise and even there is always the potential ‘wow’ factor to consider when the actual products are demonstrated live versus seeing the leaked specs.

A range of new features are anticipated which ought to be enough to get customers to upgrade. There are also set to be improvements to the Apple Watch (cellular connection) and to the Apple TV product.

The share price has retreated a touch in recent days as the details of the new devices emerged. Whilst this suggests the market is not bowled over by the specs, the stock leaped 1.8% on Monday ahead of the press conference, a little shy of its all-time peak. Currently, ahead of the US open on Tuesday the stock is up 1% in pre-market trading.

A high price to pay?

The importance of this device launch is not just hardware sales, but also what it means for customer loyalty and the Apple ecosystem. We note a potential risk if the new devices are priced too highly for customers to upgrade. If as anticipated it is priced around $1,000, the entry point is high and will make it more expensive than the MacBook Air. This will undoubtedly test some consumers’ willingness to upgrade.

But Apple customers tend to be loyal and we also note that this price has been known to the market for several days, so should not come as a surprise to investors. Apple has form here: it likes to set trends so the push for a more expensive, higher spec device as standard can be seen as the company once again setting the pace for the rest to follow. It might be a high price but Apple has worked out that its iPhones are now indispensable to their owners and they will upgrade whatever.  This looks like classic Apple – create something with existing technology (eg the OLED screen) and set the pace elsewhere, (eg price/design/usability). Apple is not always first with the tech, but manages to package it into a design and UX that consumers go for.

It would seem likely that consumers will be elastic to the price change, although the UK market may be a special case given the weakness of sterling inflating prices further. New devices retailing for c$800 last year would have set UK consumers back around £500 before the referendum vote. A device costing $1,000 today would cost British consumers c£800, a significant increase in price that may have implications for some retailers.

And this is arguably a device not aimed at mature US and European markets, but at Greater China, where Apple has suffered falling sales. The high spec, high price iPhone 8 should offer Apple a stronger, more differentiated position in this particular market. The market accounts for about one fifth of Apple revenues but revenues fell 17% last year. A return to growth here is important and the new cycle offers a compelling argument for this to happen in FY2018.

The design refresh is also important for Apple in shaping how it takes the iPhone over the next decade. It should come as no surprise that expected changes to the hardware reflect changes happening elsewhere in consumer technology; eg augmented reality and facial recognition technology.  These in turn can help lift software/app sales; eg AR, gaming, financial services. Again the ecosystem is where it really matters for ensuring sustainable growth.

At its latest trading update, Apple offered guidance for the fiscal fourth quarter for revenues of between $49bn and $52bn, which would equate to a rise of between 5% and 11% on the same quarter a year before. This indicates confidence that the upgrade cycle will be strong and there is yet nothing to dent this view. The iPhone 7, which was not a full upgrade cycle, delivered stronger-than-expected sales which suggest a supportive consumer environment for the 8th generation, even if it does look a tad pricey for some.

Services are crucial for share price

The latest trading update revealed Service revenues rose 22% to $7.3bn, a blockbuster number that makes this division the size of a Fortune 100 company all by itself, bigger than Amazon Web Services. Services delivered nearly half of all the $3bn year-on-year revenue growth for Apple in the last quarter.

And it’s rising Services revenues that make Apple ripe for a re-rating. Currently it’s trading as a hardware company, with a price to earnings ratio in the region of 18x (ttm). That compares with peers like Alphabet (34x), Netflix (222x), Facebook (37x) and Amazon (246x).

Higher earnings from Services ought to change this. These are more sustainable revenues and unlike iPhone sales, are neither dependent on delivering the next big product upgrade nor seasonal.

Services also help support new iPhone sales as they build loyalty in the Apple ecosystem. This is particularly important in the Greater China market, where it is struggling relative to every other region. It also boosts sales of other products as consumers stick to all things Apple, eg Macbook, Apple Watch.

Taken together, the various product improvements to be announced could not only get hardware sales going again but also further drive earnings in Services.”

 

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