Apple (NASDAQ:AAPL) is scheduled to release its Q1 FY2014 results on January 27th after the closing bell. The company is likely to have had a record fourth quarter on strong sales of iPhones and iPads during the holiday season. The latest iPhones, the 5S and the 5C, were launched towards the end of the third quarter and saw Apple sell 9 million units in its opening weekend, about 80% higher than the 5 million iPhone 5 units it sold a year ago. The huge pent-up demand is likely to have spilled over into the fourth quarter given the supply constraints that traditionally follow iPhone launches. The addition of China and NTT Docomo in Japan to the list of initial launch markets is likely to have further bolstered iPhone sales during the quarter. Moreover, Samsung’s (PINK:SSNLF) and Nokia’s (NYSE:NOK) not-so-strong Q4 smartphone sales indicate that Apple could have been a major benefactor this holiday season.
However, there are concerns that the 5C has not sold as well as expected, and Apple’s Q4 results will shed more light on what the sales mix has been. Either way, we don’t see this as a big concern given that the 5C was more of a margin play than market share, and higher-than-expected sales of the 5C could actually raise cannibalization concerns. We will be watching the company’s guidance for the next quarter so as to gauge how the two iPhones are expected to fare relative to each other, and if the 5C could be part of a broader strategy to push emerging market sales going forward. Our $600 price estimate for Apple is about 10% ahead of the current market price.
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5C To Increase The Market For iPhones
Margin improvement was one of the main reasons behind Apple’s introduction of the 5C last year. By pricing the 5C at a high $550, Apple seems more intent on maintaining its brand image than making a market share play. The 5C is not very different from the 5 on the inside but is held together by a single polycarbonate shell, which likely makes the 5C cheaper and much easier to assemble than its premium predecessor, which had an anodized aluminium casing. The discontinuation of the iPhone 5, and the introduction of the iPhone 5C in its stead shows that Apple is more focused on defending its gross margins with this move. It will be interesting to see Apple’s guidance for the next-quarter gross margins as the sales mix of the 5C increases following the initial launch euphoria, which might have caused sales to skew towards the 5S initially due to the higher number of purchases made by hard-core Apple enthusiasts.
Along with the gross margin improvement, we believe that Apple will be looking to derive value from the additional sales that the iPhone 5C is going to help bring in. While nothing has changed in terms of the range of prices on offer in the iPhone family (with the 5C just replacing the older 5 at what would have been its new discounted price), the company now has two new phones to promote instead of the usual one. This may not have led to the 5C performing as well as expected so far, but these are still early days and we could be seeing the impact of the huge initial pent-up demand that had built up for the 5S. Since Apple generally doesn’t refresh its products for a full year, the sales mix of the cheaper iPhones should increase going forward, with additional marketing for the 5C helping the company sell more phones over an entire product cycle than it would have with the older-generation iPhone 5. At the same time, the price differential of only $100 lowers the risk of cannibalization of the higher end 5S, which should help margins and ASP levels improve in the near-term.
China Mobile Deal To Boost Apple’s Chinese Prospects
However, this may not help Apple’s case much in emerging markets, even in places like China where carriers have started subsidizing smartphones. The iPhone 5S and 5C are being sold in China at unsubsidized prices of $867 and $735, respectively. Even carrier subsidies do not lessen the pain as Chinese subscribers have to fork out the entire cost of the phone at the time of purchase. The subsidy is then adjusted against the service fees, reducing only the future monthly payments and not the upfront cash outlay.
However, this scenario could change with China Mobile’s much-anticipated iPhone deal this year. Up until last year, only China Unicom and China Telecom had subsidy arrangements with Apple to sell the iPhone. But the entry of China Mobile, which accounts for almost two-thirds of the mobile market in China, could increase competition and lead to a subsidy war for new 3G/4G subscribers. The smaller carriers have already slashed their iPhone prices by almost 25%, anticipating greater competition from China Mobile in the coming months. Increased competition for the higher data-ARPU generating customers will help improve adoption of 3G/4G in what is still an under-penetrated market for data services. 3G/4G penetration in the Chinese mobile market currently stands at only 34%, but China Mobile’s aggressive posturing and 4G launch could help the figure grow by leaps and bounds in the coming quarters.
This will expand Apple’s addressable market in China, thereby allowing it to not only bring more Chinese subscribers into its fold, but also generating developer momentum around its Chinese app ecosystem. Apple’s sales momentum in China has decreased significantly in recent quarters, declining from a growth of around 78% in FY2012 to 13% in FY2013. Greater developer participation in creating apps for the Chinese market will not only help increase sales of the iPhone but also the iPad and any new products that Apple may be looking to launch this year.