Concern around Apple Inc (NASDAQ:AAPL) stock is overdone. Apple could see profit margin expansion.
The recently held mega launch event at the Steve Jobs theater has failed to provide an immediate boost to Apple Inc (NASDAQ:AAPL) stock. In fact, shares of the Cupertino based tech giant have been trending lower since the event. This is in spite of the fact that the launch event received favorable commentary from Wall Street. Apple stock is also one of our top stock picks from the tech sector. So what could be the reason for this decline? Well, there were some who felt that the launch event was underwhelming, some of it could just be because of profit booking. After all, Apple stock had rallied around 40% this year, going into the launch event. There are also concerns about the pricing strategy and delay in the shipment of latest iPhone models. We believe theses should not be a concern.
Will pricing strategy create a problem for Apple Inc?
There are others who are worried that by selling iPhone X at $1000, the company might have priced out a lot of customers, especially in emerging markets such as India and China. Even the iPhone 8 series is priced $30-$50 higher compared to iPhone 7 prices at the launch. However, what investors are missing is that the older models have become cheaper by $50-$100. iPhone 7 will now cost $549, down $100 from its previous price of $649 while iPhone SE will now cost $349. This is likely to spur demand for older iPhones, especially in the emerging markets. Apple now has iPhones at multiple price points from a modest $349 all the way to a pricey $1,149, targeting a whole range of consumers.
Higher priced iPhones will lead to margin expansion for Apple Inc.
On the whole, though, Apple's ASP per iPhone is likely to inch up, given that a lot of people, especially in developed markets, generally tend to buy the latest version of the iPhone. iPhone 7 was by far the world's best-selling smartphone in Q1 this year, according to a report by Strategy Analytics. And according to Statista, of the products announced recently by Apple, iPhone X is the clear favorite. The Newer version has higher ASP, which is likely to lead to higher margins. Katy Huberty of Morgan Stanley recently noted that "our supply chain checks point to an increasing mix of the higher-priced iPhone X, which drives our FY18 average selling price (ASP) up 14% Y/Y to $746, 4% above consensus estimates of $720." She has an "overweight" rating on the stock with a price target of $182.
Delay in the shipment of latest iPhones should also not be a concern.
Some analysts have also expressed concerns about the delay in the shipment. Apple will only begin shipping the latest iPhone in the first week of November. Usually, Apple makes new iPhones available for sale in September itself, which provides a boost at the end of its fiscal year. The delay in the sales has raised some concern around this quarters earnings. However, in a statement, Apple Inc has said that iPhone X sales were not included in its Q4 guidance. Apple said: "When we issued guidance for Q4 in July, we anticipated that the iPhone X would begin shipping in fiscal Q1."
A note of caution.
While analysts are expecting Apple to sell 14% more iPhones next year, a lot will depend upon how many existing users upgrade to the latest iPhone given that about 81 percent of the iPhone sales were made to existing customers this year. And there is the problem. People in developed countries are holding on to their existing iPhones for longer than usual, which could lead to lower upgrades. Phone carriers have been sounding a note of caution. During its first quarter earnings, AT&T (NYSE:T) warned that smartphones upgrade rates will be permanently lower than historical. If a lower number of people upgrade to the next iPhone, it could dampen Appel stock's party. A scenario analysis by Bloomberg Gadfly shows that iPhone sales could increase by 11% to a massive 45% depending on the number of existing users who upgrade to the next iPhone.
Bloomberg cites BTIG Research which estimates that 25.5 percent of U.S. mobile customers will buy a new phone model this year. Using this rate and the fact that existing customers make 81% of the iPhone sales, iPhone sales will increase by over 11%, lower than current analysts estimate. On the other hand, going by the previous upgrade numbers, Apple could leave analysts estimates far behind. In 2015, Apple executives disclosed that a "low 30s" percentage of existing iPhone owners had opted for iPhone 6. If we plug in this number, iPhone sales could grow by as much as 33%, much higher than current estimates.
Analysts remain bullish on Apple stock.
Apple stock is up over 35% year to date. While the 35% rally in itself is impressive, the fact that Apple managed to achieve this on its huge market cap makes this feat even more impressive. Given this massive rally, Apple will need its latest bunch of products to deliver on all fronts or the stock is likely to see a correction. The good news is that on the whole, the latest launches have received favorable reviews till now. And it's not only the iPhone. Apple Watch, which now comes with a cellular connection, has also received favorable reviews. Sales of Apple Watch were up over 50% in the June quarter. Watch shipments are expected to jump by 33% in the next fiscal. iPad is also making a comeback. On the whole, analysts remain bullish on Apple stock. BMO Capital’s Tim Long has a price target $180 on Apple stock while Drexel Hamilton has a $208 price target.
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