Apple (AAPL) knocked the ball out of the park in this week’s earnings release, boosting quarterly revenues by 12% and earnings per share by 20%. And these numbers included less than three weeks’ worth of iPhone 6 sales. (The iPhone 6 and iPhone 6 Plus were only released on September 9.) Gross margins actually expanded a little, from 37% to 38%, proving that Apple remains—at least thus far—immune from price competition. With the momentum from the phone launch still building, I expect Apple to finish calendar year 2014 with a bang.
Investors in Apple stock have a lot to celebrate right now. But iPad sales are distinctly not one of them. iPad sales actually fell during the quarter from 13.1 million to 12.3% million.
Of course, some of this weakness is due to would-be tablet buyers sitting on their wallets until the latest-generation models came available early this quarter, and were this an isolated incident I would be tempted to leave it at that. Unfortunately, it’s not. iPad sales have been consistently weaker than expected for most of 2014.
What gives? Are we witnessing the death of the iPad?
Yes. Or more accurately, “sort of.”
I’ll start with the most obvious point. Apple made a strategic decision to cannibalize its own business with the IPhone 6 Plus. The larger-screen phone makes a tablet redundant; an iPad becomes a larger version of your phone except without the ability to make regular voice calls. I consider this the right decision, as it makes the iPhone—Apple’s biggest moneymaker— more competitive with larger-screen Android devices. Forgone iPad sales are acceptable collateral damage in the far more important smartphone war.
But iPad sales had started to decelerate long before the iPhone 6 Plus was released, and the story is a little more complex than that. What I see happening to iPads—and to tablets in general—is what happened to PCs starting around 2012.
Two years after the 2010 launch of the Apple iPad, PCs sales actually went into year-over-year decline, and have continued their decline until now. The most recent sales data shows PC sales as flat this year rather than down, but the fact remains that the tablet radically changed the PC market. The upgrade cycle got stretched, as consumers made do with their older desktops and laptops a little longer and diverted the funds they would have used to upgrade to a tablet instead. And in some cases—particularly in the lower-end consumer market—buyers ditched their PCs altogether, as a tablet was more than sufficient for their modest computing needs at home, such as reading books and emails and checking Facebook.
Moving forward to 2014, we see similar dynamics at play. Consumer Intelligence Research Partners finds that American iPad buyers tend to hold on to their tablets for 2-4 years between upgrades. The lifespan of an iPhone is shorter, at 2 years or less. (On a side note, my smartphones tend to have a life of about 12-15 months; I’m a heavy user, and I have two rambunctious young boys in the house that have a talent for finding new and exciting ways to break them.)
Frankly, iPads don’t change that much from generation to generation, or at least in ways that would persuade a user to upgrade. Processing power and networking speed is fast enough at this point to last you a few years.
What does this mean for the Apple iPad and for tablets in general?
Let’s look at the PC market for clues. The PC is not “dead” by any stretch. I sit in front of one for at least nine hours per day, as do most professionals, and that won’t be changing any time soon. But I’m not buying a new one any time soon; I might use a given PC for 4-5 years between upgrades. That’s where most iPad users are today. They use their iPad regularly but there is no compelling reason to upgrade, particularly if you already have a new phone. That’s a recipe for slow growth.
The good news for Apple stock is that it really doesn’t matter. I have argued for years that Microsoft (MSFT) was an attractive stock even in the face of declining PC sales because of its cheap price, its strength in its other business lines, its solid balance sheet and its ability (and willingness) to aggressively raise its dividend.
Today, Apple is in the same position. As I reasoned in “Why Carl Icahn is (Kinda) right about Apple Stock,” Apple stock is being priced by Wall Street as a no-growth company. But its balance sheet is a fortress, it is aggressively raising its dividend and repurchasing its stock, and its other product lines outside of the iPad are stronger than ever.
Disclosures: Long AAPL in Dividend Growth Portfolio
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.