- Apple iPhone SE adoption was rather slow but is on track to reach 9 million units in FY’16.
- I believe that the slow adoption is due to weak macro in China, and broader weakness in the smartphone market.
- However, SE impact on gross margins doesn’t seem meaningful as I believe Apple Inc.’s gross margin decline is attributed to PCs.
The launch of the iPhone SE was met with some fanfare among the media and analysts alike. However, the mid-end of the smartphone market is fairly congested with competition, and weakening revenue comps in China and a difficult path to market adoption in India raises the stakes for Apple Inc. (NSDQ:AAPL) to execute across the lower pricing segments. The device itself seems to have adequate features for those wanting an entry-level high-end experience. However, it’s also become increasingly difficult for Apple to sustain y/y unit comp growth with the entire smartphone market contracting in Q1’16.
iPhone SE Estimate
Determining whether the Apple iPhone SE was a success or failure is somewhat hard to define. I believe analysts were anticipating roughly 10 million in SE shipments by the end of the current fiscal year. To determine whether Apple is on track to reach consensus figures, I conducted a quick study, based on which I will provide a FY’16 forecast for the product category alone. Furthermore, the iPhone SE has a lower ASP (average selling price) when compared to the remainder of the iPhone product segment, so it’s worth determining the extent to which it may affect consolidated gross margin. Of course, understanding the margin/product mix isn’t an exact science, but it gives us a starting point for determining whether Apple’s initial entry into the $400 price segment offers meaningful opportunities in the immediate near term.
According to Fiksu market tracker, the iPhone SE composed roughly 0.8% of the total iPhone usage mix as of May 30, 2016. Given the large installed base of global iOS users, the figures are somewhat supportive of modest success in the mid-end, which is a much larger market than the high-end smartphone market. While aggregated growth has slowed, I believe the step-down in pricing gives investors an opportunity to capitalize on the saturation of handsets across lower pricing tiers. I also don’t anticipate Apple to introduce products at lower price points. It’s also not clear whether the special edition will receive an annual or biannual upgrade cadence. However, I imagine there to be a lot of incentive for Apple to maintain a product category below $500, especially if it wants to penetrate a higher percentage of the emerging market consumer base.
Source: Alex Cho, Fiksu, BofAML
I borrow a research study from Bank of America Merrill Lynch (BofAML) to determine the global installed base by the May cut-off point, and also use Fiksu data points on iOS percentage usage to determine the number of sales. When utilizing the base expansion rate with the percentage of iPhone SE users we can arrive at a close enough approximation to hang our hats on. The above graphic is in terms of cumulative sales through the duration of the current fiscal year.
Of course, there are variances to this calculation because Apple has 13-days of inventory. Apple recognizes sales directly from wholesale contracts rather than direct retail in the majority of instances (excluding Apple retail stores). However, inventory sitting in the sales channel is roughly 5 to 6 weeks according to the prior earnings conference call. So we can probably attach another 5 to 6 weeks of unit sales to arrive at Apple’s reported figure as opposed to the number of iPhone’s that have exited the channel to the end user. Also, Apple’s reported figures in September gets cut-off by the 26th which reduces our unit assumption by another four days. So, at the low-end I’m anticipating roughly 9 million and at the high-end 10.76 million units in FY’16. I use the low-end figure to estimate the impact on ASPs.
This figure more or less corresponds with much of the sell-side commentary going into the product launch announcement. While it’s not clear if other analysts have used a similar forecast method to arrive at this conclusion, I believe that with a blend of historical adoption data and reasonable penetration assumptions. We arrive at the conclusion that iPhone SE won’t be the biggest needle mover assuming Apple sells 212.78 million units this year. The consensus estimate hovers at around 215 to 220 million units, so I’m a little more conservative here.
How will iPhone SE impact gross margins?
Even after including the iPhone SE with revised estimates for the full-year, I arrive at a full-year average ASP of $646.26. The figure differs from the Q2’16 reported ASP of $641.82 as the impact from iPhone SE launch and drop in 6S/S+ demand drove a significant reduction from Q1’16 to Q2’16 ASPs (Apple reported an ASP figure of $690.50 in Q1’16). I anticipate iPhone SE to have less than half a percentage point impact on gross margins (perhaps less). To be more specific, it was the overbuild of iPhone 6S/S+ in Q1’16 that inflated ASPs for a short duration. Furthermore, I anticipate the Apple iPhone segment to contribute $141.587 billion this year, which is higher than my prior estimate of $137.242 billion. I plan to do a full-year model revision in a future article.
If the unit-mix shift was more severe, the impact on margins would be far more noticeable. I believe that SE demand will continue to tick higher as we progress through FY’17, but it’s hard to derive reliable estimates given the timing of the iPhone 7 launch, and the potential discontinuation of the iPhone 6 line-up. But if SE demand proves to be more robust, I wouldn’t mind revisiting my financial model.
Going forward, I believe the impact from MacBook Pro refresh will be the needle mover in future quarters as the PC market is long overdue for a major refresh. Recent channel checks imply significant build-up for various PC launches in the 2016 time frame. Since PCs have lower gross margins for Apple, I believe that recent gross margin pressure came from lower iPhone-mix paired with higher concentration in Mac segment sales. I believe that if the PC segment surprises (which has the lowest margins out of its consumer electronic categories), the gross margin figure will balance out to around 38% this year, or the low-end of Apple’s range. I’ve embedded conservative gross margin figures when compared to many other analysts, so I can’t imagine things getting worse for full year gross margin.
I continue to reiterate my buy recommendation and $107.72 price target.