iPhone 7 Worries Have Been Blown Way Out of Proportion

By Markets Fool.com

In recent weeks, Apple stock has been buffeted by increasingly alarmist reports about the outlook for iPhone sales.

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iPhone sales have missed expectations this year. Image source: Apple.

The iPhone 6s product cycle has already proven to be a disappointment. iPhone unit sales fell 16% year over year last quarter, and Apple's guidance for the current quarter implies that another double-digit decline is probably on the way. Now, some media outlets are suggesting that iPhone sales will continue to sink even after the iPhone 7 hits the market this fall.

However, these reports -- which are based on supply chain leaks -- don't pass the sniff test. It's way too early for Apple's suppliers to know how many iPhones Apple expects to build this fall, let alone how many it will actually sell.

iPhone fears reach a fever pitch

Earlier this month, the Nikkei Asian Review reported that iPhone suppliers in Taiwan expect to get significantly fewer orders in the second half of 2016 than they got a year earlier. For chip foundry giant Taiwan Semiconductor Manufacturing, the article claimed that A10 processor shipments would be 20% to 30% lower than its A9 shipments last year. Moreover, TSMC is set to be the sole A10 supplier this year, whereas Samsung got some of Apple's chip orders last year.

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This would imply that Apple is expecting a massive decline in iPhone sales: on the order of a 40% to 50% drop. This simply isn't credible. First, even the struggling iPad product line has never posted a sales decline of that magnitude -- and iPhone upgrade demand is much more predictable.

Second, Apple CEO Tim Cook was upbeat about the iPhone business on Apple's earnings call last month. He wouldn't have taken such a bullish tone if he expected sales to crash and burn later this year, as he will face a massive backlash if iPhone sales declines accelerate in the next few quarters.

Instead, these reports seem to be a case of people reading too much into a limited slice of supply chain data. Cook has repeatedly warned analysts and reporters about the dangers of doing that. Nevertheless, some Wall Street analysts appear to be taking the Nikkei Asian Review report at face value.

A brighter outlook

Analog Devices' recent earnings report provides a more plausible explanation for what's going on here. Analog Devices, a major Apple supplier, reported that revenue fell 5% last quarter and expects a similar decline of about 5% this quarter.

Analysts initially took this news as another sign that Apple is expecting weak demand for the iPhone 7. However, on Analog Devices' earnings call, CFO Dave Zinsner suggested that the projected decline has to do with the timing of Apple's chip orders.

Analog Devices doesn't expect iPhone 7-related production to pick up until July, the last month of its fiscal third quarter. That means the peak demand from Apple will fall into the following quarter.

More broadly, this suggests that other suppliers probably don't know Apple's true expectations around iPhone 7 demand. Furthermore, Apple itself doesn't know how much demand there will be. A lot will depend on how many iPhone 6 and iPhone 6 Plus users decide to upgrade this fall.

iPhone 7 sales will depend heavily on how many iPhone 6 users upgrade. Image source: Apple.

Apple probably wants to maintain as much flexibility on inventory as possible this year, given that demand hasn't lived up to its expectations in the past six months or so. In that context, it wouldn't be surprising if Apple starts with fewer orders than it did last year. It can then put in more orders after it has a chance to assess initial demand levels in September.

Use your best judgment

Supply chain data can be useful for assessing iPhone sales trends. It's an early indicator of short-term demand fluctuations, albeit an imprecise signal. Supply chain rumors did correctly forecast the current iPhone sales slump.

However, supply chain rumors aren't likely to produce good predictions of longer-term iPhone sales trends. The recent Nikkei Asian Review report projecting a massive sales decline will likely go down as one of the more egregious examples of this problem.

The article iPhone 7 Worries Have Been Blown Way Out of Proportion originally appeared on Fool.com.

Adam Levine-Weinberg is long January 2017 $85 calls on Apple. The Motley Fool owns shares of and recommends Apple and is long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.