The iPhone 7’s Potential Impact On Apple’s Pricing, Margins & Market Share

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Apple (NASDAQ:AAPL) unveiled the new iPhone 7 on Wednesday, as it looks to spruce up its flagship product, which has been contending with slowing shipments and mounting competition from Android-based rivals. While the new device remains visually similar to the iPhone 6S, it does sport some noteworthy technological enhancements. Below we take a look at how the iPhone 7 could impact the key valuation drivers for Apple’s iPhone business.

We have a $120 price estimate for Apple, which is about 10% ahead of the current market price. We estimate that iPhone accounts for about 52% of Apple’s stock price.

Unlikely To Move The Sales Needle

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The iPhone 7 sports relatively compelling technology improvements over the iPhone 6S, including better cameras and displays, water resistance and stronger computing performance, which could give many existing iPhone customers coming off two-year contracts and installment plans enough reason to upgrade. That said, the new devices could be a harder sell in growth markets such as China and India, where lower-priced devices from local vendors already offer many similar features with more contemporary designs, at significantly lower prices. Overall, we continue to believe that the iPhone’s market share will see a slight decline through the iPhone 7 cycle (FY’17), with the rumored 10th anniversary iPhone – which is expected to sport a complete design overhaul – driving a strong upgrade cycle next year.

ASPs Could Remain Flat Or Decline

While the regular-sized iPhone 7 models will maintain the same price points as last year, the iPhone Plus devices have seen a $20 price bump, starting at $769. That said, we expect overall ASPs to decline with the iPhone 7. The new phones sport 32 GB of base storage, which should be sufficient for most mainstream users, reducing the need to pay $100 or more for higher storage tiers. The 16 GB/64 GB strategy was a big driver of Apple’s ASP uptick with iPhone 6/6S. Secondly, the iPhone 7’s relatively dated design could hurt Apple’s pricing power, as smartphone customers have become increasingly accustomed to design innovation from Apple’s rivals, who have been offering modular devices, bezel-free designs and curved displays. Apple had to resort to mid-life cycle promotions for the 6S – which was viewed as being too similar to the iPhone 6, and it’s possible that the iPhone 7 could encounter the same issue.

Gross Margins May Contract 

We believe that Apple’s overall gross margins could see a slight contraction due to the iPhone 7. While the aforementioned ASP decline will be a factor, Apple is also likely to see some costs rise. Production rates on the dual lens camera system– the signature feature of the 7 Plus – could be low, raising Apple’s bill of materials costs (about $40 higher, per KGI Securities).  Secondly there could be incremental costs associated with raising the storage capacity, particularly for the top-end 256 GB model. That said, there may be some positives as well; with the same industrial design being repeated for the third straight year, costs for mechanical components and assembly should be kept in check. Moreover, the Wall Street Journal reports that Apple has been actively pushing for discounts from its components suppliers in order to protect margins. [1] While Apple has guided for overall gross margins of 37.5% to 38% for the quarter ended September 2016, largely in line with recent quarters, we will only see the margins effect of iPhone 7 in the holiday quarter.

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Notes:
  1. Apple Squeezes Parts Suppliers to Protect Margins, WSJ, September 2016 []