Apple's (NASDAQ:AAPL) shares have performed well of late, off their recent sub-$400 lows to around $500 today. The company's recent earnings call most assuredly gave CEO Tim Cook a sigh of relief, as the market cheered the results and the stock has had an upward trajectory. Interestingly, the stock has rallied in the face of some apparently troubling updates on Apple's traditionally high margins.
Margins on the iPhones dropped from 42.8% in the year-ago-quarter to 36.9%, signifying a drastic decrease in the amount of money apple generates from each unit. Forbes explains,
"[a] year ago, Apple was making $607.85 per iPhone in revenue, while today the company reported $581.10 per unit. The same fact shows up with iPads, Apple second-best selling device, with 14.6 million units shipped in the third quarter. Apple now makes $436.07 in revenue per iPad, a 15% decline from a year ago."
There is substantial speculation about why the margins are dropping, but it is clear that when Apple breaks out the numbers, we can see only 50% of iPhone sales are for the newest model, while consumers are also opting for the older generation models at discounted prices. Indeed, on the earnings call, Tim Cook admitted as much, pointing to"strong" sales of 4 and 4S units as the primary reason margins decreased quarter-over-quarter, when the 3GS was not as attractive. So while Apple actually broke its record for most iPhone's sold in a quarter, clocking in at 31.2 million units, the squeeze on margins kept Apple's numbers from being truly surprising to the upside. But do margins tell the whole story? There are reasons to believe that Apple will be poised to take advantage of the back-to-school and holiday shopping seasons, and perhaps even seen margins tick upward as well.
Low Cost iPhone
Could a new, lower cost iPhone actually improve Apple's margins?Some analysts seem to think so, and if executed right, it is possible. Right now, consumers not opting for a new generation iPhone 5S have the option of purchasing 5, 4, and 4S models. Of course, once flagship handsets in their own right, these older models, that bear the same materials and costs they did when they were newly released, do not sell for as much anymore, given their age. As a result, the profit margin Apple garners from selling these units is lower than when the device is brand new and commands a high price point.
How could a new, less expensive iPhone change this dynamic? First, the price point begins lower than a new, high end model. This in turn will attract consumers who desire owning an iPhone but do not, or cannot, spring for the high end. In places like China and Brazil, a low cost iPhone could conceivably tap into this lower end market and compete with devices from competitors like Samsung where it traditionally has not competed, or has only offered older models, and their lower margins. And although attracting a new market does not necessarily affect the math on Apple's margins, it could absolutely buffer their importance to investors, as the sheer volume of the iPhone units can drive the revenue numbers higher, even if they are not making as much per unit. If Apple is able to sell millions more iPhones, even at a lower margin, revenue can improve.
Instead of selling the 5, 4S and 4 units at reduced prices that shrink Apple's margins, the new bargain model has a fresh slate, and components and manufacturing will be designed in a way so that the lower price point could still garner a higher margin than selling a 4S at a reduced price would. Analysts at ISI Group tend to agree, positing that a low-end handset could attract margins of 40%+. If Apple is able to achieve a solid gross margin on the bargain model, and leverage this into selling a large volume of units, the updated product mix will bode well for Apple's revenue, earnings, and conceivably its stock price.
Of course, introducing a new product in the fall/winter quarter could spark some of that consumer sentiment Apple has enjoyed over the years. Perhaps you won't see long lines around the corner on launch day, but any catalyst that can drive foot traffic and sales is welcome.
Readers of Feria know that there is good reason to believe the data on the improving economy, even in light of the recent stock market sell-off. Retail sales are signaling an improving economy, as the Commerce Department reported core retail sales up half a percent in July. The recent US GDP print, revising the growth rate upward to 2.5% also showed an improving economy. Consumer confidence, measured by such surveys as Thomson/Reuters and the Conference Board's index of sentiment also point to a more optimistic shopper. Finally, jobs numbers have been positive, albeit somewhat unsatisfactory; yet growth continues. The winding down of the Federal Reserve's Quantitative Easing, coupled with rising oil prices appear to have the potential to be headwinds for the consumer, and the stock market more generally, so how the economy absorbs these elements will tell the tale of the holiday shopping season.
But with an updated product mix and attractive price points, shoppers could reward Apple with another blockbuster holiday quarter. The consumer appears to be in the strongest position financially in years, being the most optimistic in years, with the most jobs available in years. If Apple can once again be the pick of holiday shoppers, it stands to gain handsomely from their generosity. Further, if Apple can improve the margins on its flagship iPhones, and in turn continue to sell them in record numbers, revenue at Apple will climb, and the stock price should reflect this. Apple is a good long-term play this holiday season if it can provide the spark the consumer is looking for, so we would like to take a "wait-and-see" approach to the new launch in early September. But if you believe the launch to be promising, now may be a good time to buy.
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.