Apple Earnings Preview: New iPhones In Focus

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Apple (NASDAQ:AAPL) will release its Q4 FY 2014 earnings after the markets close on Monday, October 20, reporting on an eventful quarter that saw the company introduce a slew of new products including a large screen iPhone. It’s fair to assume that the new iPhone models will be the primary driver of earnings (despite the fact that they went on sale only towards the end of the quarter), given the pent up demand for a big-screen Apple handset as well as the higher average selling prices and margins that the device is likely to command. However, Apple’s initial supply constraints and the possibility of a larger mix of lower-priced – or discounted – iPhone shipments earlier in the quarter could weigh on the results. Overall, Apple has guided for revenues between $37 billion and $40 billion, while it expects gross margins to come in at between 37% and 38%. Below is a quick take on some of the trends that are likely to influence Apple’s earnings for the quarter.

Trefis has a $97 price estimate for Apple, which is slightly below the current market price.

See our complete analysis for Apple here

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iPhone 6 Should Be Accretive To Margins

While the broader smartphone market has been contending with falling prices and margins owing to commoditization, Apple could actually succeed in getting customers to pay more for their handsets with the introduction of the iPhone 6. The company has priced the iPhone 6 Plus at $749 onwards, which represents a $100 premium to the iPhone 6 model. According to preliminary estimates from IDC, the iPhone 6 costs about $200 to build (including manufacturing expenses) while the iPhone 6 Plus costs just about $16 more, meaning that it is likely to have higher gross margins. [1] While early reports state that the sales mix has been skewed towards the iPhone 6, it is likely that the iPhone 6 Plus will gain significant traction as Apple irons out manufacturing issues and launches in markets such as China, where many consumers have a preference for larger screens. A favorable mix of 6 Plus models should give iPhone revenues and margins a healthy boost going forward.

Apple has also been looking to make the higher storage capacity models of the iPhone more appealing to customers. While the company has typically launched iPhones in 16 gigabyte (GB), 32 GB and 64 GB capacities, charging a $100 premium and $200 premium for the higher storage models, the company will now be offering models in 16 GB, 64 GB and 128 GB, presenting the higher storage models as a better value proposition. This should have a beneficial impact on gross margins, since we estimate the incremental cost of a 64GB model over a 16GB model to be less than $30.

However, it is unlikely that we will see the full impact of the margin improvement in this quarterly report, given that Apple is likely to have resorted to discounting older or lower-spec iPhone models such the iPhone 4S and iPhone 5C to drive volumes and clear out inventory prior to the launch of the iPhone 6.

Mac Sales Likely To Remain Strong, iPad Could Struggle

Although the Mac isn’t nearly as big a driver of Apple’s valuation as the iPhone, it has emerged as one of Apple’s strongest performing products this year. During Q2 FY 2014, Mac shipments grew by around 18% year-over-year to around 4.4 million units, defying a shrinking global PC market. Some factors driving growth include strong product differentiation, increasingly attractive pricing and cross-selling to the company’s large base of iOS users. We believe that the Mac should have another strong quarter, driven by the back-to-school buying season as well as demand from markets such as China. Preliminary numbers from IDC indicate that quarterly Mac sales grew 8.9% year-over-year, while the rest of the industry saw sales fall by about 1.7%. [2]

We expect Apple’s iPad shipments to remain lackluster, considering the slowing tablet market and the impending launch of new models, which is likely to result in customers postponing their purchases. During the previous quarter, iPad shipments declined by about 9% year-over-year to around 13.3 million units, marking the second straight quarter of year-over-year declines. IDC forecasts that tablet shipments for the year will rise by 12.1%, compared to a growth rate of around 51.8% during 2013. [3] Additionally much of the growth in the tablet space is coming from the low end of the market (sub $200), which Apple may not be interested in entering. Apple’s iPads, particularly the Mini, could also face increasing cannibalization from the iPhone 6 Plus.

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Notes:
  1. iPhone 6 Plus: $100 Costlier for Consumers to Buy—Just $15.50 More Expensive for Apple to Make, IDC, September 2014 []
  2. Global PC Shipments Exceed Forecast with Mild Improvement in Consumer Demand, While Apple Moves to #5 Spot, IDC,  October 2014 []
  3. Worldwide Tablet Shipments Miss Targets as First Quarter Experiences Single-Digit Growth, According to IDC, IDC, May 2014 []