Since Apple's (NASDAQ:AAPL) fiscal 2013 ended the 30th of September, I find it fitting to share my thoughts on what I expect to see from Apple over the next year. While previous articles on Seeking Alpha have also discussed the prospects for the new year, this article will have a higher focus on the quantitative part.
I plan to make a series of two articles, with this article focusing on iPhone earnings, and the next article will take a closer look at Apple's other segments.
A quick overview of the iPhone segment
Earnings related to the iPhone segment have slowed down over the last year. As seen in the below graph, sales and revenue are still growing, but margins have deteriorated a bit, which has reduced the earnings growth rate.
Source: My own estimations based on Apple's earnings reports.
The main reason for the lower profitability is the lower ARPU (average revenue per unit) of the iPhone. In a previous article, I argued that the decline was caused by an increased consumer preference for older iPhone models. Since older models are sold at a discount relative to the most recently launched, Apple earns less for each iPhone it sells today than it did two years ago.
In this article I will try to assess the impact this trend will have over the next year. I will also quantify the impact of other relevant variables, and after that I will come up with an earnings-estimate for the iPhone segment.
Methodology for earnings forecast
To forecast earnings of the iPhone business segment, I will estimate the below 3 variables;
- Total iPhone sales in 2014.
- Sales of iPhone 5s relative to 5c and 4s.
- Gross margin of the iPhone 4s, 5s and 5c.
Revenue can then be calculated as:
- iPhone sales * ARPU for each iPhone model (this is done for the 5s, 5c and 4s)
- Earnings for each iPhone model is calculated as; ARPU for each iPhone model - Cost per iPhone.
- Gross profit of the iPhone business segment = Earnings per iPhone * iPhone sales
The first variable I will attempt forecast is the amount of iPhones sold over the next 12 months. My sales forecasting methodology consist of 3 steps;
Step 1: Estimate sales industry sales for emerging and developed markets respectively
Step 2: Estimate Apple's market share in emerging and developed markets respectively
Step 3: Calculate the estimated sales figures by multiplying the market share forecast with the market size forecast
For the first step, I simply use the forecast provided by IDC. In the below table we can see estimated sales for the industry over the next 4 years. But what we are really interested in is the growth rate from 2013 to 2014. Developed markets are expected to grow by 17% and emerging markets are expected to grow by 24%.
This is pretty good for news for Apple as it implies that sales will increase as long as Apple doesn't lose a big part of its market share.
In emerging markets, I expect that the majority of the consumers will be more interested in the cheaper Android phones, however, Apple will also benefit from the partnership with China Mobile, which will offset the market share loss that I otherwise would have expected.
In developed markets, I expect the market share to decline a bit as the cheaper smartphones offered by Apple's competitors will become relative more attractive.
Despite the loss in market share, iPhone sales will actually increase according to my forecasts. To be more precise, I expect global iPhone sales to increase from 151M to 179M.
Which iPhone will be the most popular?
With the news that Apple would launch a new cheap iPhone in 2013, I had expected that Apple would be able to solve two issues at the same time;
- It would increase Apple's market share in emerging markets where it currently isn't performing too well.
- A new lineup could also have a positive effect on Apple's gross margin in developed markets
But after Apple announced a price of $550 for the 5c, it seems obvious that it doesn't really help with the emerging market-issue, but as can be seen in the below table, it is definitely beneficial for gross margins.
So while the 5c doesn't accomplish as much as I hoped for, it is definitely not correct (as I wrote in my most recent article) that it doesn't accomplish anything.
Over the next year, I expect that the 5s will sell twice as well as the 5c. I also expect that the increased popularity of the low-end phone will continue. Overall, my assumptions imply that the percent wise sales of the high-end iPhone (the 5s) will continue its decline.
Source: My own estimations based on Apple's earnings reports.
Given these assumptions, we should expect the ARPU to decline over the next year. This means that the growth rate in revenue will be lower than the growth rate in unit sales.
iPhone earnings over the next year
The last assumption that is needed to forecast iPhone earnings is related to the gross margin of the various iPhone models. From estimations by iSuppli, we know that the iPhone 5s is the most profitable followed by the iPhone 5c, and due the lower selling price of the 4s, this model is the least profitable. Thus, I assume that the gross margin of the 5s is 56%, the gross margin of the 5c is 50% and the margin of the 4s is 38%.
Given these assumptions, we can see (in the table below) that margins will remain constant in the next year. So while I expect the old model (4s) to increase in popularity, the decline will be offset by the higher margin of the mid-ranged iPhone. Due to higher unit sales, I expect gross profit to increase by $7.5B over the next 12 months.
While I was a bit disappointed of Apple's decision to launch the iPhone 5c at a price of $550, that doesn't mean I am bearish on Apple. The iPhone 5c is still beneficial for Apple as it holds the hand under Apple's margins. The industry is also still growing, and therefore I expect both revenue and gross profit to increase over the next 12 months.
Over a longer period, iPhone earnings will definitely come under pressure if Apple doesn't come up with a strategy targeted towards emerging markets, however, for the time being it makes sense to be bullish on 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.