Investors continue to lap up the Apple (NASDAQ:AAPL) phenomenon as rumors about an impending iPhone 5 launch gain ground. Despite having reported muted Q3 FY2012 results that fell short of the market expectations just four weeks back, the stock has seen tremendous buying interest, rallying more than 16% since and breaching the previous high of $642. Apple is now the most valuable publicly traded company ever in U.S. history, having surpassed Microsoft’s (NASDAQ:MSFT) previously held record of $616 billion with a current market cap of $624 billion. As the stock inches closer to our fair price estimate of $700, we evaluate the various drivers that could take Apple even higher and become the world’s first trillion dollar company.
Summary of key drivers:
Before delving further, let’s first consider the historical trends of Apple’s main drivers for growth:
- iPhone market share: The iPhone’s global mobile phone market share has steadily increased from zero at the start of 2007 to around 5.4% in 2011. Although 5% may not seem big, Apple deals primarily in smartphones, and the market size we have considered is the global mobile phone estimate, which includes a large number of feature phones sold in emerging markets as well.
- iPhone pricing: The iPhone’s pricing has in fact increased over the past two years and stands at around $630 as of 2011. The iPhone’s incredible popularity has helped Apple maintain a premium pricing and command at least 70% of the industry’s total profits every quarter. 
- iPhone gross margins: The iPhone’s margins have declined since the launch of the iPhone in 2007 when it was over 60% to what was around 55% in 2011.
- iPad unit sales: The iPad was launched in April 2010 and Apple sold around 15 million iPads in 2010. But in 2011, the sales shot up almost 275%.
50% upside to Trefis price estimate | Apple’s stock value of $1053
1. Faster increase in iPhone market share (+15%):
We expect the iPhone’s global mobile phone market share to increase to around 13% by the end of our forecast period. However, the iPhone is Apple’s flagship product and contributes more than 55% of our price estimate. So, even a small outperformance in respect to its market share will have a huge impact on Apple’s valuation.
The company has been posting average annual growth of close to 90% in iPhone sales over the last three years. Last year’s holiday quarter saw the iPhone set a new quarterly record of 37 million unit sales, with the phenomenal success of iPhone 4S. With iPhone 5 rumors being a drag on iPhone sales ahead of the new phone’s launch, it will be important that the iPhone 5 continues on the 4S’ success and more than offsets the previous quarter’s weaker demand. If the iPhone 5 manages to do that and Apple continues to set the same scorching pace in the coming years, the upside to our price estimate could be huge.
A number of factors could help Apple maintain its historical growth rate. Rapid expansion of operations in overseas markets, the addition of new carriers, and iPhone sales in emerging markets such as China present a huge opportunity to increase market share. (see Apple Is Headed To $700 With China Growth And iPhone 5) Apple already has two of China’s three carriers in its list of carriers that sell the iPhone and a deal with China Mobile is the cards after the recent Qualcomm announcement. China Mobile’s addition could alone mean an almost 18% upside to our current $700 price estimate. Meanwhile, the developed markets may see little traction for competing smartphones such as the BlackBerry and the Lumia, further bolstering Apple’s share.
These triggers could propel iPhone’s market share higher than we currently forecast. There could be an upside of 15% to our price estimate if the iPhone market share exceeds our current end-of-period estimate by about 4 percentage points.
2. Slower decline in iPhone pricing (+10%):
We currently forecast the average iPhone price to decline to around $400 by the end of Trefis forecast period as Apple enters emerging markets and increasing competition forces Apple to cut prices, beyond the customary slashing of prices of the older models in the future.
However, iPhone’s average pricing has increased over the last two years as continued demand for the newer as well as higher-end versions (32GB/64GB) of the iPhone have improved the mix while Apple has reduced the prices of the older ones. Traditionally, Apple has targeted only the high-paying customers and not aimed for a mass market presence, unlike its competitors.
These factors could mean that iPhone pricing could decline at a slower rate than what we forecast. There could be an upside of 15% to our estimate for Apple’s stock if iPhone pricing declines only to $500 by the end of our forecast period.
3. Slower decline to iPhone’s gross margins (+10%):
We currently estimate that iPhone’s gross margins will decline to around 40% by the end of Trefis forecast period. However, if Apple manages to sustain higher iPhone pricing levels, its margins could stay high.
Input costs are likely to remain constant or even decline as technology improves and Apple buys out smaller companies that help reduce its supply costs. Earlier this year, Apple announced that it had bought Israeli startup Anobit, a move that would bring down NAND flash memory costs for Apple. Moreover, we have also seen Apple diligently manage its supply chain issues in the past. In the first quarter of last year, when the whole mobile phone industry was reeling from the supply chain aftershocks of the earthquake in Japan, Apple managed to post better-than-expected iPhone sales. (see Apple Avoids Hiccups in Supply Chain, Raising Estimates on iPhone Outlook).
If Apple continues to handle the pricing and input cost issues well, its gross margins may decline at a slower rate to what we forecast. If iPhone’s gross margins decline to only around 48% by the end of Trefis forecast period, there could be an upside of 10% to our price estimate for Apple’s stock.
4. Faster increase in iPad unit sales (+10%):
The iPad debuted in early 2010, spawning a new market segment of mobile devices and sending Apple’s stock even higher. Many competitors have tried to enter this still relatively nascent market segment, but none have come close to threatening the iPad’s dominance. Even the much touted Kindle Fire, a 7-inch Amazon tablet which was released during the holiday quarter last year, made hardly a dent to the iPad, which set a new record of more than 15 million unit sales in a single quarter.
The iPad is the second most valuable business for Apple after the iPhone and accounts for just under 12% of our Apple price estimate, but if the nascent market sees an explosion in demand over the coming quarters, the iPad could command a bigger chunk of our estimate.
Gartner estimates that the iPad market will grow to about 170 million unit sales in 2016, at an average of about 35% annual growth rate.  If Apple is able to grow its iPad sales at only 30% annually, its sales at the end of 2016 would be around 150 million, about 50% higher than our current estimate of 100 million. That could add another 10% upside to our price estimate for Apple’s stock.
5. A new iProduct (+5%)
So far, we have considered only Apple’s existing products. What if Apple comes out with a new, innovative product such as the much rumored Apple iTV, and it kicks off like the iPhone or the iPad? In one of our previous analyses, we had seen that the rumored iTV would add only about 5% to our price estimate. (see Apple’s Rumored iTV Plans Don’t Add Much To $700 Stock Value) But the halo effect of the iPhone and the iPad on the next iProduct could be huge, and the consequent upside to our price estimate much more than the 5% estimated.
But therein lies the biggest risk to Apple’s stock.
Apple’s success has hinged on its ability to surprise the market with one innovative product after another. Should it fail even once, the market euphoria will die down. Also, there is the law of large numbers. Apple has so far bucked the trend by tapping nascent markets, or as in the case of the iPad, by creating one. How long the Apple dominance will roll on is difficult to predict for now. But if the company continues to rise meteorically as it has in the recent past, the first trillion dollar company may not be so far along.Notes:
- Apple, Samsung take 108% of handset profits — wait, what?, August 6th, 2012 [↩]
- Gartner Says Worldwide Media Tablets Sales to Reach 119 Million Units in 2012, April 10th, 2012 [↩]