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By Brian Colello, CPA | 04-27-2015 05:00 PM

Emerging Markets Power Apple’s Results

Strong iPhone sales in China and other emerging markets boosted the tech giant even as iPad sales disappointed and the company struggled to meet demand for the Apple Watch, says Morningstar’s Brian Colello.

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AAPL Apple Inc

Brian Colello: Apple reported another quarter of terrific results. The stock is up about 1% after hours. IPhone growth was just tremendous again. They sold 61 million units, and most of it came from emerging markets. We expected China to be a growth driver because of the addition of China Mobile as a partner and also through the Chinese New Year, and those sales delivered. China was up more than 70%. A lot of other emerging markets were up 80%, if not doubling, year over year. If there was a disappointment from this quarter, it was that iPad, again, was a little weak. I think we are seeing a clear cannibalization of iPads by larger-screen iPhones.

The company also expanded upon its dividend and buyback program. It raised its dividend 11%. It added another $50 billion to its buyback program. So, in total, they are going to return $200 billion to shareholders over the next few years. Since they are generating almost $60 billion of operating cash flow and probably even more this year and in the upcoming year, we don't think they will have any problem making those capital distributions to shareholders.

Apple's revenue forecast for the third quarter was solid, $46 billion to $48 billion of revenue--about what was expected. If there was any problem, it was the gross-margin guidance for [the third quarter]. They are guiding 39% for the company as a whole. We would have expected it to be a little bit higher because of the Apple Watch. We would expect that to be gross-margin accretive. Certainly, if they are selling a $10,000 watch and some of the wrist bands, we thought that would actually be higher margin or higher than the corporate average. Instead, they hinted that it's lower than the corporate average.

I think they are having some supply problems with building these Apple Watches. Clearly, the new orders are being pushed out to June anyway. So, there is some clear supply constraint in the early going for the Apple Watch. It looks like it's going to be hitting margin as well. That is a little bit of a disappointment. They refuse to say whether that's something that's going to be a long-term problem or if this is just a short-term hiccup from launching a new product. We still tend to think it's a short-term issue, but it's certainly something that bears watching.

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