Apple: Hardware or Tech Services? A Q3 FY25 Earnings Preview

Key Predictions

• Anticipated Q3 FY25 Revenue: $89.1-$89.3 billion (+3.7-4.2% year-over-year)

• EPS: $1.42-$1.43 (+1.4% year-over-year)

• iPhone Revenue: $40.1-$40.6 billion (+2.2-3.3% year-over-year)

• Services Revenue: $26.9-$27.0 billion (+10.7-11.3% year-over-year)

• Gross Margin: 45.5-46.5% (vs. 47.1% in Q2)

• Tariff Impact: -$900 million

• Year-to-Date Stock Performance: -13% to -20% decline

Major Challenges: Tariffs and Supply Chain Issues

Apple finds itself at the epicentre of the Trump administration's tariff imbroglio. The President has threatened to impose a 25% tariff on iPhones not manufactured in the US, which could elevate the consumer price by as much as $3,500. Producing iPhones domestically could significantly curtail sales within the US due to the prohibitive cost. Furthermore, Apple's product competitiveness has waned in recent years, with rivals having caught up or even surpassed the company in the smartphone market.

In response to tariff risks, Apple is accelerating the shift of production from China to India, where approximately 20% of iPhones are currently manufactured. The company's strategy envisages most iPhones sold in the US originating from India by the end of 2026. This is an ambitious objective, given that Indian production is 5-10% more expensive than in China due to higher component costs and lower factory efficiency. Additionally, China has imposed restrictions on engineers' travel, complicating the transfer of technical expertise.

Paradoxically, this relocation may not entirely mitigate the risks. Donald Trump has also announced the potential imposition of 25% tariffs on India. Ultimately, however, this may not lead to a modification of Apple's plans. The company already sources over 70% of phones for the US market from India. Moreover, experts indicate that most US phone sales occur through carrier subscriptions, meaning even a slightly increased phone cost due to tariffs would add only a few dollars to the consumer's monthly payment. Production diversification is still expected to be cost-effective and superior to commencing actual production in the US.

Delays in AI Strategy

Apple lags significantly behind its competitors in the artificial intelligence race. While Microsoft, Google, and Meta are investing tens of billions in AI infrastructure, Apple allocates only $12 billion annually to Capex, compared to upwards of $80+ billion for its rivals. The much-anticipated Apple Intelligence service remains fully unavailable, and a crucial Siri update has been postponed until 2026.

The company is also losing key AI specialists to competitors such as Meta and OpenAI. Apple's privacy-centric approach limits the development of cloud-based AI solutions, whereas rivals are constructing powerful data centers equipped with Nvidia chips.

Transformation into a Services Company

A positive aspect is the dynamic growth of the Services segment, which has become a primary driver of margin expansion. Services revenue surged from $53.77 billion in 2020 to $96.17 billion in 2024, achieving a 12.3% CAGR. This segment now accounts for approximately 21% of total revenue and boasts higher margins than hardware sales.

Apple has surpassed one billion paid subscriptions within its services ecosystem, and App Store revenue per download has nearly doubled to $0.98. This trend helps the company maintain record gross margins despite a decline in iPhone sales.

Outlook and Risks

Analysts anticipate a "solid quarter," propelled by iPhone demand in China and pre-tariff purchases. However, long-term prospects raise concerns. A lack of a clear AI strategy and high valuations (P/E nearing 40) coupled with low growth rates suggest that Apple shares are susceptible to a markdown, even with the current year-to-date decline of 13% and a one-year decline of approximately 4%.

It is estimated that Apple has approximately 1.5 years to present a convincing AI strategy before it negatively impacts iPhone sales. Meanwhile, OpenAI is developing its own hardware devices in collaboration with former Apple designer Jony Ive, further intensifying competitive pressure.

Apple remains the world's third most valuable company with a market capitalization of $3.2 trillion, but its dominance in the premium segment could be threatened by increasing competition in AI and geopolitical trade tensions.

Since May, the stock has been in consolidation, in contrast to the broader market, which has not only recovered losses but is now practically recording new historical highs day by day.

Source: xStation5