Apple's March Uptrend Is No Sucker Rally

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) has rallied 7.8% since recording a 52-week low of $419 on March 4. This is not the first time the tech giant has experienced a promising recovery since slipping to below $600. Nonetheless, the previous occasions have proved to be nothing short of a "sucker rally", which means, a stock price increases for a short period of time before declining back to its usual position or even further below. This is normally attributed to speculation by investors following some news release or in anticipation of some news release. Apple seems set to avoid the trap this time round, though critics would argue that it's still too early to judge.

Apple's stock movement catalysts

The iPhone 5 has been touted as one of the major reasons Apple has dipped in value following the heavy investment in the making of the device, which now competes against aggressively priced rivals. This strained the company's margins during the September quarter, and the strain is only beginning to fade. Apple is currently on the recovery lane toward improving its margins, as iPhone 5 sales trickle in against less fixed costs.

Following the launch of the device, there was high anticipation from investors, which helped in rallying the stock to a price of $705 in late September. Nonetheless, this was wiped out soon after it emerged that, there were some supply constraints that could limit the company's iPhone 5 sales. The iPhone is Apple's largest revenue generator, which means the company's performance highly relies on it.

The iPad is also under threat from cheaply priced counterparts from rival firms. Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), and Microsoft (NASDAQ:MSFT) are all trying to breach Apple's dominance in the tablets market. The iPad is the second highest revenue generator in Apple's books, which means any pressure on that business unit is mapped on the company's stock price.

Apple seems to have recovered from the shocks inflicted by supply chain constraints in both the iPhone and iPad product lines. According to a recent note to investors by Morgan Stanley, Apple's price is highly correlated to its gross margins, which have displayed a cyclical movement over the years. The analysts believe that Apple's gross margins are set to improve citing that the capital investments made to support iPhone 5 and the new iPad contributed to the decline in the GM.

Apple has already signaled a reduction in capital expenditure in its most recent quarter guidance, which should help improve gross margins. However, this scenario would also see a reduction in sales volumes, and hence revenues. Therefore the biggest paradox is whether a decline in gross margins is more harmful to Apple's stock than a decline in revenues. The former seems to carry the day here as exhibited in the company's price history.

So, could we confidently say that Apple is certainly bottoming, and hence a continuous rally? I wouldn't bet against that. The March quarter results are expected to be significantly affected by capital investment made during the December quarter for the manufacture of the iPhone 5, and the new series of iPads. However, following the guidance issued in Q4, the June quarter certainly looks set to deliver better margins. So, will the investors be looking at a three month span or a little further? The latter should be the case unless you are a momentum trader, or a speculator.

Cheap iPhone for China to aid troughing

There is a lot of optimism that Apple could come up with a cheaper iPhone for China, and the rest of the emerging markets. The world's most populous nation offers a lot of opportunity to the iPhone maker, but only if, it can get the business going with China Mobile (NYSE:CHL), the country's leading carrier with over 700 million subscribers. The challenge is, a majority of these customers use mobile phones and not smartphones, which suggests a cheaper smartphone, could do the trick in converting a huge chunk of them to smartphone owners.

Indeed, smartphones account for only 25% of the global mobile phones, meaning the vast majority in the emerging markets remain untapped, and up for grabs. Apple's cheaper iPhone, which Credit Suisse analysts believe could generate gross margins of 38%, could be a game changer for the iPhone maker. Several analysts believe that Apple is currently working on a new iPhone product set to address both the low-end and high-end markets. Can they all be wrong? If right, this wouldn't need much capital investment as the iPhone we know. The only caution here is, Apple must not forget how it differentiates itself from the rest, in coming up with quality durable and unique products.

The Bottom Line

Apple has maintained bullish recommendations from analysts despite its unimpressive showing at the stock market. The company has consensus rating of buy, with 41 buy ratings from leading analysts, 8 neutral ratings and only 2 sell ratings. The average target price is at $607, or 34.27% upside of Wednesday 20, closing price. Among the latest buy ratings, are those from Credit Suisse and Canaccord Genuity, both at $600.

Apple has recently hinted that it might issue some cash back to investors through either stock buybacks, or bonus dividends among others. Whether it's out of willingness or pressure from shareholders it's a debatable question. But the fact remains that the company's $137 billion cash hoard gives the company flexibility to invest in new products without having to knock at the bank manager's door. So a cheaper iPhone would come at no sweat, I would think.

The company's margins are improving and this can only get better towards the second half of 2013. Investors have proved to judge Apple's performance and outlook based on its margins, and should therefore do the same based on better margins as predicted. It's not too late to buy Apple.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.