- New iPhone launch was relatively successful.
- Analysts/investors are more optimistic; stock price continues to move higher in response.
- I’m currently projecting 232 million iPhone shipments for FY’17, and I'm raising my rating to high-conviction buy.
Apple Inc.'s (NASDAQ:AAPL) stock is sustaining momentum given promising preliminary data on iPhone 7 launch according to the analyst consensus. This is driving heightened expectations on y/y shipment growth, pricing mix, and margin/multiple expansion.
A brief summary of the new features for iPhone 7/Plus: dual lens camera, haptic feedback for home button, iOS 10, internal component improvements, water-proofing, wireless connectivity, base/maximum storage increases, better color accuracy for retina display, and design changes.
Initial Take On iPhone 7 Cycle
While the improvements were in-line with much of what we have seen over prior iPhone generations, it was really hard to disappoint on the 7th generation, as the entire analysts/journalist community set such a low bar. Furthermore, the various fire incidences regarding the Galaxy Note 7 reasserted a pro-Apple case for many consumers wanting to upgrade this year.
While I’m not knocking down Apple’s current generation model, I wanted to note that the recent refresh went as good as it possibly could post the Steve Jobs era. As such, I want to start by emphasizing that in Apple’s current environment, the “magical” Jobs effect has diminished over the years, but refresh still seems intact.
Various analysts are anticipating the iPhone 7S to carry more substantial features. So, with the initial success of the iPhone 7, we may see a sustained pattern of y/y growth (even into FY’18). I believe Apple reserved some new features for the next-generation model, as it’s the 10-year anniversary model. Assuming that’s the case, we can hope for sustained growth as the 7-series sounds far more promising than its prior 6-series counterpart.
Key data from the analyst community
In the prior weeks, some promising data points were shared via various members of the analyst consensus. This is very different from prior-year where we witnessed substantial underperformance given channel checks and on-going revisions to earnings/sales models across the board.
Here’s what Gene Munster from PiperJaffray mentioned in his most recent report:
Our survey showed that 98% of buyers in line to buy the iPhone 7 were already iPhone users, while 2% were Android users. This is the highest percentage of iPhone launch customers we have ever recorded as current iPhone users.
Additionally, 34% of iPhone 7 buyers said they plan to buy an Apple Watch in the next year, which is up from 19% in our iPhone 6S survey and essentially in-line with the 36% from our iPhone 6 survey.
Apple’s customer base remains loyal, but demand for the iPhone 7 is mostly derived from the more aged installed base. This implies that the 5S and prior-generation models are mostly represented in the base mix shift towards 7/7Plus models. 5S and prior models compose 35.61% of the current installed base, according to Fiksu iPhone usage monitor.
Credit Suisse analyst Kulbinder Garcha made some salient points in his most recent Apple note:
We now estimate the iPhone 7/7 Plus mix to be 67%/33%, an improvement over the 70%/30% mix that the iPhone 6s cycle saw. The survey also showed that ~60% of iPhone users plan to upgrade their phones within 1 year, with an implied replacement rate of all iPhone users of ~29 months, faster than the 32 months we assume in our installed base analysis.
The analysts at Credit Suisse also anticipate 3% y/y shipment growth (reasonable and conservative), and iPhone ASPs to improve by $29 from $632 to $661. The improvement in ASPs will be another important driver to y/y revenue comps (which I will explain in more detail in another article). Furthermore, unlike prior-year where Garcha cited concerns pertaining to the supply chain, his current Asia channel checks are a lot more supportive of y/y unit growth.
Garcha (Credit Suisse) anticipates 221 million iPhone units, Katy Huberty (from Morgan Stanley) at 219 million, Wamsi Mohan (BofAML) at 242 million, Gene Munster (from Piper Jaffray) at 234 million, Steven Milunovich (UBS) at 228 million, Amit Daryanani (RBC) at 223 million, Andrew Uerkwitz (Oppenheimer) at 197 million.
Based on my sample, the current consensus view implies FY 2017 shipments of 223 million units. This implies mid-single digit y/y shipment growth when compared to FY’16 (assuming 212 to 213 million units for FY’16, which is my current estimate).
Likelihood of an earnings beat remains high
Katy Huberty from Morgan Stanley also jumped in with some thoughtful commentary on necessary refresh for y/y unit growth :
We think Apple has over 600M iPhone users today. We conservatively assume 30% of iPhones are sold to new users - Apple has been tracking ahead of that in recent quarters - which accounts for 66M of the 219M iPhones we model for FY17. So only 25% of the current installed base needs to refresh for Apple to sell the remaining 153M iPhones.
Based on my understanding, the 25% threshold is very reasonable, as 35.61% of the installed base (as mentioned earlier) is composed of iPhone 5S and prior generation models. Furthermore, the survey data from Gene Munster implied that a record number of pre-existing iPhone owners were standing in-line for the iPhone 7 model, which implies that the last remnants of the aged installed base are making the move to either iPhone 6S/6SPlus or iPhone 7/7Plus.
Given Huberty’s stance is nearly in-line with the current consensus view, her forecast assumptions are a reasonable base to work off from. Apple will likely perform above 25% installed base replacement, and could perhaps trend closer to high 20s. Furthermore, smartphone cycle sits at 3-years currently, which implies that nearly all iPhone 5S and prior users will likely replace iPhone’s this year. In that case scenario, I could imagine 174 million iPhone units from prior generation (or 29% of the total installed base) to refresh and 25% of shipments to be composed of new iPhone users, which translates into 232 million unit shipments for FY’17.
Consensus view is appx. 223 million units, therefore I’m approximately 9 million units above the consensus.
Assuming the current iPhone base is 600 million, I’m forecasting installed base growth of 9.6%, which translates into 58 million incremental units. This totals out to an installed base of 658 million units by the end of FY’17.
I believe Apple will report a solid streak of earnings beats given the conservative stance of the consensus, which de-risks earnings-fueled disappointments. Nonetheless, Apple stock has priced in some of these assumptions already. I believe there is more room to this rally, as Apple stock already trades at a discount due to the severity of disappointing quarters leading up to Q4’16 (ending in September).
I know some of you could simply point to the charts, and mention that Apple stock is trending higher. But, it’s in my view that fundamentals will always dictate price action. Since this rally is mostly driven by fundamentals as opposed to sentiment, I could imagine Apple stock trading at much higher levels.
As such, I’m re-rating Apple stock to a high-conviction buy, and will re-initiate my price target in the next couple of articles.