- Initial order figures imply iPhone 7 production target of 75 million units, but there's no confirmation from investment bank channel checks.
- While the figure seems attainable, there are meaningful differences to this year's supply chain, which we analyze under a microscope.
- iPhone 7 gross margins are likely comparable to iPhone 6S/+ with feature additions indicative of meaningful consumer adoption.
Things have gotten very interesting, and while it’s not yet clear if Apple Inc. (NASDAQ:AAPL) will deliver outstanding results in FY’17 (I have yet to model my estimate that far), I believe the right news flow is coming from both the supply chain and internally to get investors excited in the name again. It also helps that Warren Buffett provided much-needed confidence by buying $1 billion worth of Apple stock. With the world’s best value investor making a well-timed entry, the remaining value crowd will also get aggressive on the name.
Notwithstanding, Ming-Chi Kuo providing clarity on Apple iPhone7 and MacBook Pro refresh and with WWDC 2016 right around the corner, investors are getting more aggressive here. The iPhone 7 anticipatory trade kicks off with the reigning endorsement of Buffett Inc. stamped on top.
In terms of channel checks, we didn’t hear from Ming-Chi Kuo yet… His canny insights into iPhone estimates are time-tested and tend to hold water. While I have worked diligently to gain insights from the sell-side, I have yet to garner much traction from KGI securities, so I’m going to go with Bank of America Merrill Lynch as its Asia Research Division is comparable to some of the Taiwan-based checks.
The response from BofAML somewhat negates the initial reports, so I’m guessing the data isn’t as air-tight, but Wamsi Mohan mentions that if production mix completely shifts to iPhone 7, then their 57 million iPhone 7/7+ and 10 million iPhone 6/6+ figure when combined takes us closer to the ball park, we then have to assume 13 million contribution from 6S/6S+ and SE to arrive at Mohan’s 80 million shipment estimate for Q1’17:
The media reports suggest that a production target of 75mn units (mid-point) would make this the highest production target in the past two years, and much higher than the consensus estimate of 65mn units. In terms of sales, we modeled about 74mn iPhone 6/6 Plus in 2014 and about 70mn 6S/6S+ in 2015 (Apple does not disclose sales by iPhone model). Apple could also choose to discontinue the 6/6+ concurrent with the launch of the iPhone 7, that could move the mix more favorably. We model 10mn iPhone 6/6+ in the Dec quarter this year, which could end up as iPhone 6S or iPhone 7 units. We currently model 57mn iPhone 7 units to be sold this year (15mn in the Sept. quarter, and 42mn in the Dec. quarter).
The initial order rumors are above analyst consensus, which ironically creates upside to expectations after a year where heightened expectations led to a series of earnings misses. Furthermore, the figures are only preliminary with component flexibility of roughly 10 million units (similar to prior cycles), as the third-party ODMs (Foxconn and Pegatron) have spare capacity from “over investing” in the iPhone 6S cycle. In terms of semiconductors, I believe there’s flexibility at Taiwan Semiconductor (NYSE:TSM) to ramp wafer volumes if demand exceeds initial order requirements, so in terms of component flexibility, there’s less supply-driven risk even if demand is above trend.
Memory is also over-supplied based on semiconductor checks (from basically everybody) so there’s very minimal risk on storage pricing despite the potential launch of a 256 GB configuration. I’m anticipating NAND-storage prices to decline even further, and Apple will sustain a comparable bill-of-materials to prior year’s model on storage. In fact, the shift to higher storage may prompt further speculation of consumers buying up the stock leaving room for margin expansion despite higher component cost from three camera sensors, glass externals and OLED display.
Potential bottleneck would be the casing and enclosure as Apple is transitioning to full glass casing with some aluminum support. It’s hard to tell if there’s any supply chain flexibility for the exterior casing, but I would imagine the supply chain provisioning capacity for better than expected demand in the initial production ramp.
The report on glass casing comes from Ming-Chi Kuo. It’s likely that glass furnaces are being built somewhere, perhaps Catcher? There was also a 16% y/y increase to Corning’s Capex last year with most of it heavily concentrated in Q3’ and Q4’15, which probably has more to do with Apple’s transition back to glass-on-glass displays for the iPhone 7 (OLED creates some complications with Apple’s in-cell display technology).
I’m not sure if Corning is the main supplier for the back exterior casing, but the durability of gorilla glass seems compatible, and the capacity could still be there. However, full gorilla glass for the exterior could also prove cost prohibitive, so the speculation centers more on Biel Crystal Manufactory, which is the primary glass manufacturer for Samsung and Apple. Getting confirmation is difficult as Biel Crystal is not publicly traded quite yet, so we can’t rely upon publicly disclosed financial figures for confluence or confirmation of a massive glass cover order. However, given the timing of Biel’s potential IPO in late 2016 or early 2017, it does imply that Biel Crystal is looking to cash in on a major Apple contract.
Rumors from unreliable sources point to sapphire glass as the display cover glass, but given past reports of less light refraction and ramping CapEx at Corning I’m extremely skeptical of sapphire making an introduction in 2016. In other words, we can collectively doubt Apple risking supply chain disruption following the debacle with GT Advanced Technologies. There’s enough capacity for sapphire glass when pertaining to camera lenses and Apple Watch displays, but I haven’t heard of major developments in this space from reliable sources.
I view the recent pull back as an opportunity to get back into Apple stock. The recent news on Apple iPhone 7 seem supportive of a major product launch with enough feature additions to drive product refresh. Also, I’m still on the fence with regard to reports of the removal of the 9mm audio port. With the iPhone 7 expected to be thicker, there’s no technical reason for why a 9mm port is no longer compatible design wise. However, Apple is known to make transitions in the form of feature omissions (remember when Apple abandoned disc drives, floppy drives and mechanical hard drives before everyone else). I believe the logic behind the reports is somewhat consistent with Apple’s ongoing minimalist design philosophy. Basically, Apple could, in fact, launch the iPhone 7 with wireless headphones/earbuds as accessories, but that might be reserved for the iPhone 7S instead of the 7.
That being the case, I continue to reiterate my $107.72 price target and buy recommendation. The stock is undervalued, and I anticipate mean value reversion despite the low likelihood of Apple meaningfully exceeding estimates in 2H’16.