Here’s Why Apple Suddenly Looks So Vulnerable

“This too shall pass.”

These words were spoken yesterday by the CEO of the largest and most influential tech company in the world. The company that defined how we use computers, that designed the smartphone as we know it today, that not long ago was believed to eventually be worth $1 trillion. The bromide is hardly a rallying cry of technology innovation, let alone a cheer of celebration, but Tim Cook found himself using it as analysts peppered with questions about how Apple will rebound in a global economic slowdown. And it pretty much summarizes how Apple is faring.

“We’re in a challenging global macroeconomic environment. We’re seeing extreme conditions unlike anything we’ve experienced before just about everywhere we look,” Cook said in a conference call discussing earnings. “Even in the markets where today, grandly, it looks fairly bleak—from Russia and Brazil and some of the other economies that are very much tied to oil-based economies—we do believe that this too shall pass.”

The rout in oil markets, the turmoil in China’s financial markets and the abrupt slowdown in emerging economies have sent global markets spinning lower this month. Now their effects are being written into the earnings reports that Apple delivers each quarter to investors. And the results are not great.

Apple beat its earnings per share by few whiskers while its $75.8 billion in revenue fell short of Wall Street’s $76.6 billion forecast–the rare miss from the financially conservative company. Worse, Apple said that its revenue in the current quarter would decline to between $50 billion and $53 billion. The mid-point of that broad range is 13% below Apple’s revenue a year ago.

The only good news about the report was that the bad news it contained was largely expected. One benefit of the obsession that Apple’s earnings tend to inspire is that many investors and analysts had months to see a slowdown in iPhone and iPad sales coming. Apple’s stock fell in after-hours trading, but only slightly: down 2.6% in late trading.

“Overall, given the ‘white-knuckled fears’ going into this,” wrote FBR Capital analyst Daniel Ives, “we would characterize the overall headline performance as better than feared.” Gene Munster of Piper Jaffray added, “Now that the March and June iPhone numbers have been reset, we believe investors will have more confidence to invest.”

Slowing iPhone sales are a particular concern for Apple investors because the smartphone drives 68% of Apple’s revenue and because iPhone revenue has never declined year-over-year ever since it was introduced in 2007. iPhone sales typically slow down ahead of the bi-annual release of a major iPhone release, but earlier slowdowns never translated into outright declines.

One analyst on the conference call calculated that Apple’s guidance implied a 15% to 20% drop in iPhone sales this quarter. Cook said he didn’t see them falling that far but confirmed they would decline. His comments focused on new areas of growth, such as services like Music, Pay and iCloud for the 1 billion Apple devices that were used last quarter.

CFO Luca Maestri said that services sold for those 1 billion iPhone, iPads and Macs generated $31 billion last fiscal year and $9 billion last quarter alone, a 24% increase from the year-ago period. But that’s only about one-ninth of Apple’s total revenue, so the strongest growth is coming from a small part of the overall business.

Apple also downplayed a decline in operating profit last quarter. Cook boasted of “Apple’s strongest results ever” and Maestri touted “all-time records for net income and EPS.” Apple reported its net income per share rose 7% to $3.28, but most of that gain came as Apple retired 288 million outstanding shares through its stock repurchase program.

Factor that out, and net income rose only 1.9% to $18.361. But the reasons for the gain had to do with lower income taxes and increased income from dividends and interest Apple receives from its vast stockpile of cash. Factor those out, as operating profit does, and Apple showed a slight decline of 0.03%.

Apple is far from a company in need of a turnaround, but many investors are awaiting new products that will revive the growth of the past two years. Even with a new model due this fall, the impact of iPhone growth is tapering over time, and placeholder products like TV and Watch, while growing, aren’t making up for slowing sales in more important products.

Apple’s stock has lost 28% of its value since it reached its all-time high of $134.54 last April. New products from the tech giant and a recovery in the global economy may indeed prove Cook’s assertion that all this shall pass. In the meantime, Apple remains a company with annual revenue well above $200 billion a year.
But the company is also a longtime bellwether—perhaps tech’s sole bellwether right now—and that the company’s most optimistic message is currently one of muddling through doesn’t bode well for the sector.

It’s not the kind of encouraging message Cook is used to delivering, but for now it will have to do.