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Commentary

Apple Sell-Off May Create Buying Opportunity

We think the market’s reaction to the Apple Watch’s slow start is overdone, and we’re sticking with our fair value estimate on the back of stellar iPhone demand.

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 Apple (AAPL) reported solid fiscal third-quarter results that were modestly ahead of our expectations, but it was not a blowout quarter because of the newly launched Apple Watch. IPhone demand remains stellar, especially in China, but unit sales and revenue from the Watch were below our expectations. Supply constraints were certainly part of the Watch shortfall, but perhaps early demand for the device was tepid as well. While the Watch appears to be off to a slow start, we're far from calling the device a flop, as iPod and iPhone launches faced similar early challenges but exponential growth and mass adoption thereafter. Overall, we view the 7% after-hours decline in Apple's stock to be overdone. We expect to maintain our $140 fair value estimate and narrow moat rating, and with an after-market-close price of $122, we view the sell-off as the start of an adequate margin of safety for investors.

Apple sold 47.5 million iPhones in the June quarter, slightly below expectations but still up a hearty 35% from the year-ago quarter. Unit sales in greater China remained spectacular, up 87% year over year. Yet iPhone average selling prices were surprisingly flat, which we view as a great sign for iPhone product mix as Chinese customers aren't solely buying the older, cheaper models. Apple's revenue from other products was $2.6 billion, which we think implies that the firm earned about $1.5 billion from the Watch, based on sales of 3 million units at a $500 ASP.

For the September quarter, Apple expects revenue of $49 billion-$51 billion. While this range represents 16%-21% year-on-year growth, we also think it implies that the Watch won't provide a meaningful revenue boost to Apple next quarter either. We're not especially surprised by this and anticipate that Watch sales may rise exponentially in the December quarter during the holiday season.

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Brian Colello does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.