Brand Momentum, Solid Margins Should Drive Apple’s Watch Business Despite Some Shortcomings

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Apple (NASDAQ:AAPL) revealed additional details on its first wearable device, the Apple Watch, in a media event held on Monday. The device will start shipping in nine countries beginning April 24. The two mainstream models of the watch – Watch Sport and Watch – will be priced starting at $349 and $549, respectively, with prices ranging up to $1,099, depending on the case size and type of wristband. The Apple Watch has a quite a lot going in its favor. It addresses some of the issues that have riddled the smart watch category by offering an attractive design, an intuitive user interface, solid fitness tracking capabilities and support for third-party applications. However, there are some fundamental problems that remain unaddressed on the Apple Watch. Firstly, based on the apps and use cases that Apple showed off during the event, the watch still seems to lack a so-called killer application and the incremental utility that it offers over an iPhone remains debatable. Additionally, battery life, which has been advertised at about 18 hours is no improvement over current smart watches and this is likely to remain a quibble with customers. However, despite the issues, we expect Apple’s strong brand momentum and its loyal base of iPhone users to help the device get off to a strong start. We also expect the product to have a positive impact on Apple’s overall margins, given its high selling prices and potentially low manufacturing costs.

Our $128 price estimate for Apple is about in line with the current market price.

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High ASPs And Low Component Costs Should Bode Well For Margins

Apple appears to be positioning the Watch as a luxury item, potentially giving up volumes in favor of higher pricing and margins. While bill of materials data is not available for the Apple Watch, we believe that the company’s custom designed hardware, chip architecture and the fact that the many electronic subsystems of the watch are integrated into a single module could help to keep component costs low. For the sake of comparison, the iPhone 6 – which has a larger screen and battery, more NAND and DRAM memory and also sports cameras, fingerprint sensors and pricey wireless chips – is estimated to cost just about $200 to build. [1] We think it’s fair to assume that the bill of materials for the Apple Watch will be just a fraction of that. Additionally, the company’s strong bargaining power with suppliers and contract manufacturers should further help costs. However, key cost drivers are likely to be associated with the physical aspects of the device (casings, sapphire crystal), the display assembly (which research firm NPD DisplaySearch estimates could cost $27 per unit) as well as the complexities arising from the various design combinations that Apple intends to offer. Based on our preliminary ASP forecast of $400 for CY2015, we estimate that the Apple Watch will realize gross margins of around 42%, which is ahead of the company-wide average. The number could be meaningfully higher if the sales mix is skewed towards more premium models.

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Notes:
  1. iPhone 6 Plus: $100 Costlier for Consumers to Buy—Just $15.50 More Expensive for Apple to Make, IHS, September 2014 []