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Piper Jaffray: Concern of drooping sub-30% Apple margins is 'overblown'

post #1 of 10
Thread Starter 
In a research note on Thursday, Piper Jaffray analyst Gene Munster said buy-side investors' concerns that Apple's gross margin will see a two-year decline to below 30 percent is unlikely, specifically noting the company's important iPhone margins are stable.

AAPL
Performance of AAPL stock over past six months. | Source: Bloomberg


Munster believes investors are unduly worried about an Apple margin dip as the company prepares to enter the mid-tier smartphone market with a rumored low-cost iPhone. Such a device, the argument goes, will cannibalize the flagship iPhone's market share and pull down overall gross margin, as the handset is a major profit driver for Apple.

"We believe concern that margins will drop below 30% in the next 2 years is overblown," Munster wrote in the report shared with AppleInsider. "While we believe iPhone margin is stable, we can build a case for a 32% gross margin in 2015 (Street at 37%), but it would require a nuclear meltdown in Apple's model including 50% cannibalization of the regular iPhone from the cheaper iPhone, a 15% margin on the cheaper phone, and a 10% margin on the TV."

Munster is referring to a much rumored television set Apple supposedly has in the works, a traditionally low-margin consumer product.

The analyst currently sees iPhone margin at about 55 percent despite Apple's drop in gross margin from 42.8% in June 2012 to 37.5% in March 2013. According to Munster, the downturn the most recent quarter was likely a product of strong iPad mini sales and an estimated $414 million hit from the combination of new Chinese warranty policies and what Apple called an "unfavorable adjustment."

Going further to prove that iPhone margins are stable, the analyst calculated what Apple's margins would look like if no iPad minis were sold from December 2012 to March 2013. The result was a rise in overall gross margin, from 39.7 percent to 40.2 percent over that period.

As for the effect of a low-cost iPhone, Munster is modeling sales at 50 million units for 2014, and 100 million units in 2015, down 25 million each year because the handset has yet to materialize. With an implied 50 percent cannibalization rate to the full cost iPhone, up from the analyst's prior estimates of 30 percent, and an adjustment in margin from 15 percent to 30 percent, the net result is an overall margin reduction of 40 basis points in 2014 and 140 bps in 2015.

Here Munster notes that if the cheaper iPhone turns out to be more successful than the expected 7 percent marketshare for 2014, the impact to Apple's overall margin could be greater. In that case, however, a hit to margins would also result in positive profit growth.

iPhone Margin
Despite modeling a conservative 15% gross margin for the low-cost iPhone, Munster offers a "more realistic" estimate in the chart above. | Source: Piper Jaffray


Munster also sees some investors thinking that Apple will one day degrade to Samsung's operating margins, which stood at 14 percent for the 2012 calendar year. Because the Korean company produces a wide range of products, the electronics division alone making everything from TVs to washing machines, the comparison is flawed.

Adding to the argument is a favorable component pricing environment going forward, something that Apple CFO Peter Oppenheimer alluded to during the company's most recent quarterly earnings conference call.

Regarding an Apple television, Munster doesn't expect such a device to enter the picture until 2014 and has thus not included it in his model. He expects an announcement to take place at the end of the year, with shipments going out in 2014, with a selling price of $1,500. Margins could be as high as 20 percent, but normally TVs carry gross margins of 10 percent or below.

TV Margins


Given the new model, Munster is maintaining an Overweight rating for AAPL, but is adjusting his price target to $655 from $688 due to 5 percent lower earnings per share estimates for the 2014 calendar year.
post #2 of 10
A three year prognosis, based on two unannounced products, produced at unknown cost, sold at unknown prices and cannibalizing an unknown amount of higher margin device sales. And that as precise as one decimal figure. These guys rock.
post #3 of 10
Quote:
Originally Posted by dreyfus2 View Post

A three year prognosis, based on two unannounced products, produced at unknown cost, sold at unknown prices and cannibalizing an unknown amount of higher margin device sales. And that as precise as one decimal figure. These guys rock.

 

Ten out of 100 have no clue about percentage calculation and theory of errors.

 

That's nearby 13.7583 %!

post #4 of 10
I believe in Apple just like Gene Munster here, but seems like Gene is now sounding just like many analyst around. First, he needs to drop the story about Apple TV. He mentiond we would see it in 2012 and them he changed it to 2013 and now it is 2014. Dude, let it go - You are loosing your face here. Secondly, your story is positive than why did you lower your target price?
post #5 of 10
I've owned Apple since the Macintosh -which were built in the US- and still own Apple products. But the Wall Street crowd's dunned enthusiasm for Apple stock- plummeting from $700 to below <$400 is another example of overkill (both ways). But these "analysts" conjectures on margins (lower, Lower!) are, in real life, based on the fact that Apple was forced- by publicity- to make (ask?) their vendors to, at least in appearance, to not use slave labor (then paying Foxconn employees ridiculously low wages even after the fact of their found out exploitation). I find it interesting that the corporate West will deal with the Chinese who still have vast gulags filled with slave laborers- not unlike their brethren North Korea- but then again today's prettified Capitalism is just fascism with a farcical, kinder face.
post #6 of 10

So.. analysts and investors simultaneously, want Apple to create a shitload of cheap products, yet maintain their current margins at the same time. Brilliant. It's like they expect Apple to be able to play by some different, magical economic rules than every other company on the planet, and when they can't, they get punished. 

post #7 of 10
Such a device, the argument goes, will cannibalize the flagship iPhone's market share and pull down overall gross margin, as the handset is a major profit driver for Apple.

 

Apple gets most of its revenue from hardware margins.  Right now.  But eventually they'll need to evolve the company to generate more and more revenue from content and services.  Hardware costs drop over time, thus retail prices drop over time due to low-cost competition among other things.  But, since Wall Street is chronically short-sighted, incapable of any thinking beyond the next 90 days, gradual migrations to new business models look like declining profits and mismanagement of resources.  And, as we've seen umpteen times, Wall Street can and will punish anything but short-term quarter-by-quarter focus.

 

So how can Apple start moving toward that eventual content-and-services-revenue future?  Well, for one, they can start accumulating more iCloud and iTunes accounts.  The more the better.  Especially if and when Apple leverages that massive user base for their inevitable television solution.  And how can they bring more users to iCloud and iTunes?  How about a lower-cost iPhone?  (No, stupid, not the iPhone 4 or 4S.  A new model that actually costs Apple less to make.  The old models still have all those expensive components.  And the iPhone 5 will still be expensive and difficult to make throughout its lifecycle, presumably until late 2014.)

 

And as with the iPad mini, Apple will likely need to sacrifice margins to achieve a lower price point with the low-cost iPhone.  So the analysts in the "market share is everything" camp will be happy.  And the analysts in the "gross margin is everything" camp will be unhappy.  You just can't win with those guys.

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post #8 of 10
Quote:
Originally Posted by radster360 View Post

I believe in Apple just like Gene Munster here, but seems like Gene is now sounding just like many analyst around. First, he needs to drop the story about Apple TV. He mentiond we would see it in 2012 and them he changed it to 2013 and now it is 2014. Dude, let it go - You are loosing your face here. Secondly, your story is positive than why did you lower your target price?

 

I was thinking that too, he has been kicking the TV can for some time now. But at some point Apple will have to make a move, so he is saying 2014 and Apple will announce it earlier. imo they will either update the TV box soon or announce the TV. Notice how they skip the TV update this winter.

 

He is lowering the price target because Apple, well, has come to an complete halt in terms of EPS. Apple return to growth is not going to be easy.

post #9 of 10
Quote:
Originally Posted by SockRolid View Post

 

Apple gets most of its revenue from hardware margins.  Right now.  But eventually they'll need to evolve the company to generate more and more revenue from content and services.  Hardware costs drop over time, thus retail prices drop over time due to low-cost competition among other things.  But, since Wall Street is chronically short-sighted, incapable of any thinking beyond the next 90 days, gradual migrations to new business models look like declining profits and mismanagement of resources.  And, as we've seen umpteen times, Wall Street can and will punish anything but short-term quarter-by-quarter focus.

 

So how can Apple start moving toward that eventual content-and-services-revenue future?  Well, for one, they can start accumulating more iCloud and iTunes accounts.  The more the better.  Especially if and when Apple leverages that massive user base for their inevitable television solution.  And how can they bring more users to iCloud and iTunes?  How about a lower-cost iPhone?  (No, stupid, not the iPhone 4 or 4S.  A new model that actually costs Apple less to make.  The old models still have all those expensive components.  And the iPhone 5 will still be expensive and difficult to make throughout its lifecycle, presumably until late 2014.)

 

And as with the iPad mini, Apple will likely need to sacrifice margins to achieve a lower price point with the low-cost iPhone.  So the analysts in the "market share is everything" camp will be happy.  And the analysts in the "gross margin is everything" camp will be unhappy.  You just can't win with those guys.

 

Apple is doing great with services and sales on itunes, its just that its still a drop in the bucket compare to the massive amounts coming out the hardware business. Since Apple is the only hardware makers for its OS's, it needs to cover the entire markets, so that means adressing the low end. They can get away with applying good margins on the low end stuff, but they still need to offer something at that level to preserved the ecosystem and keep it from painting themselves in a niche corner.

post #10 of 10
Quote:
Originally Posted by SockRolid View Post

 

Apple gets most of its revenue from hardware margins.  Right now.  But eventually they'll need to evolve the company to generate more and more revenue from content and services.  Hardware costs drop over time, thus retail prices drop over time due to low-cost competition among other things.  But, since Wall Street is chronically short-sighted, incapable of any thinking beyond the next 90 days, gradual migrations to new business models look like declining profits and mismanagement of resources.  And, as we've seen umpteen times, Wall Street can and will punish anything but short-term quarter-by-quarter focus.

 

So how can Apple start moving toward that eventual content-and-services-revenue future?  Well, for one, they can start accumulating more iCloud and iTunes accounts.  The more the better.  Especially if and when Apple leverages that massive user base for their inevitable television solution.  And how can they bring more users to iCloud and iTunes?  How about a lower-cost iPhone?  (No, stupid, not the iPhone 4 or 4S.  A new model that actually costs Apple less to make.  The old models still have all those expensive components.  And the iPhone 5 will still be expensive and difficult to make throughout its lifecycle, presumably until late 2014.)

 

And as with the iPad mini, Apple will likely need to sacrifice margins to achieve a lower price point with the low-cost iPhone.  So the analysts in the "market share is everything" camp will be happy.  And the analysts in the "gross margin is everything" camp will be unhappy.  You just can't win with those guys.

 

I agree with this 100%.  Most people don't see the big picture where Apple is heading.  Tim Cook himself said that they are no longer just a hardware company.  IMO the end game is to have over a billion iOS users that purchase movies, music, tv shows, credit card transactions, ect.  Amazon and Apple are actually on a colission course to be the ultimate provider of all content.  There will be a point where Apple won't even need to make huge margins on hardware.  The re-occuring revenue from content will surpass $100 billion a year. 

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