Apple Sell-Off Looks Overdone

Brian Colello: Apple (AAPL) reported third-quarter earnings tonight, and the results were viewed by the market as a disappointment. The stock sold off almost 7% after hours. We think the sell-off is a little bit overdone. We think investors might have been expecting a blowout quarter because we had the new Apple Watch launch. That didn't come to fruition. It's clearly not a mass-market product yet; but because of the supply problems that Apple had, we should have already known that it wasn't going to be a big number from the Watch.

June revenue was $49.6 billion, which was a little ahead of consensus; but again, not a big beat. IPhone unit sales were a little light at 47.5 million units. Consensus was about 49 million, but we are not concerned about a small miss during the summer months. This is the off period for iPhone sales anyway as many customers wait for the new product to come up.

I think the biggest issue was the Apple Watch, and the revenue implied from it. It's lumped into their bucket of other product revenue. That revenue number was not especially promising. It implies that the Watch revenue was not strong. Again, we think it was off to a slow start anyway because of production issues. These numbers imply that it was an even slower start than what we would have expected.

Apple did say that they sold more Watches to end customers than iPhones and iPads in their initial launch, so that is an encouraging sign. But at the same time, we all know that Apple has many more users than it did in years past. So, if there was one advantage of the Watch, it was that they were selling to a much larger user base.

So, although the Watch is not a mainstream product yet, we would not call it a flop by any means. If you look back to the original iPod and iPhone launches, they were especially slow starts over the past couple of years. I think investors were all spoiled a little bit by the very strong iPad launch in 2010, but that was a product that had a robust app store from the iPhone and didn't have the same sort of learning curve that the other products did. So, I think the Watch mirrors more of the iPod and the iPhone in terms of new revolutionary products.

Looking ahead to September, Apple forecasts revenue of $49 billion to $51 billion. Again, this is a little bit below consensus expectations. It doesn't imply that there is a huge ramp-up in Watch revenue now that supply is meeting demand, but we wouldn't really have expected that anyway. We think the Watch, at this point, is much more of a holiday product. So, we are looking forward to advancements in the software and the app store leading up to the holiday season.

So, again, the fourth-quarter forecast for September is a little light but not especially disappointing in our eyes. Again, we think the general sell-off in the market--down 7% after hours--is a little bit overdone.