Categorised in: Breaking Financial News
Last week, the market demonstrated its way of being irrational by shedding more than $60B off of Apple’s (AAPL) valuation in a mere two days. That’s 110 times Netflix’s (NFLX) annual profit, six times AMD’s (AMD) valuation, three times Snap’s (SNAP) valuation, or more than the entire value of Tesla (TSLA). I actively trade Apple but find it difficult to entirely close a position because Apple is very innovative, dominant, and profitable; three great characteristics of a business. No business is perfect and hiccups play a role in every success. In my last article, I wrote about HomePod and some of its shortcomings. More importantly, this time I’m going over iPhone X, why the device is just a hiccup, and why you shouldn’t dump your shares over it.
What happened Thursday & Friday?
On Thursday, we saw Taiwan Semiconductor’s (TSM) shares tumble 5% because of a disappointing earnings and guidance report. The chipmaker blamed a “very high-value smartphone.” Tied together with Bloomberg’s estimate that Apple makes up 21% of TSM’s revenue, investors were given good reason to believe that Apple’s latest iPhone was underperforming.
To add to the pain, Morgan Stanley (NYSE:MS) issued caution on Friday towards Apple as it suspects that the upcoming iPhone “Super Cycle” has yet to arrive. While Morgan Stanley remains bullish on Apple, it trimmed iPhone expectations to 34M units. That’s 20% less than the street’s census of 43M units. As a result, Apple’s shares fell by over 4% in a single day and I believed it was a good opportunity to pick up shares, so I did.
The iPhone X Hiccup
There’s no company that innovates, dominates, and profits like Apple. Apple has $280B in its cash vault and had a net profit of $50B last year. Apple’s vertical integration of its iPhone yields unmatched margins, allowing it to allegedly take 86% of all smartphone profits. That doesn’t mean it’s perfect.
Apple has built a strong brand loyalty and any product that it launches comes with extreme demand right off the bat. Apple’s most recent report shared that iPhone X was its most popular phone even though it was released in November, which was later in the quarter. Analysts are indicating that HomePod and iPhone X sales are stumbling, which means that the early adopters and strong loyalists are boosting sales in the beginning, but it’s not sticking with the masses.
The blame is simply due to the price of the phone. It’s very difficult for the masses to find value in paying $1,000 for the iPhone X, but Apple wants to maintain its margins so that’s the price the company demanded. Because of the premium OLED display, the iPhone X costs $120 more to manufacture than the iPhone 8. With an estimated margin of 67% on the phone, this means that for every $100 Apple spends manufacturing the device, the customer is charged $270.
Beer at a bar has similar margins. If $10 buys you a nice glass of beer, wouldn’t you expect that $30 gets you a pitcher instead of three glasses? For the masses, who are the customers such as myself waiting to replace their iPhone 6S or iPhone 7, the prettier screen isn’t worth an extra $250. Furthermore, the intended lack of iPhone 8 innovation has made it even less tempting to upgrade, leading to a delayed “super cycle.”
If Apple doesn’t negotiate on its price or offer a phone that’s more innovative than iPhone 8 while being cheaper than iPhone X, the “late adopters” may still not be buyers. In my opinion, the $670 profit on iPhone X invites competitors to quickly join the ranks. Samsung (OTC:SSNLF) is a perfect example, offering 50% off of its brand new Samsung Galaxy 9, a competitor to iPhone X. This is perhaps why renowned Apple predictor Ming-Chi Kuo believes that Apple will launch a third iPhone model this summer.
Source: MacRumors, KGI Securities
I believe that the iPhone X is a hiccup, but also an easy fix. If Apple’s upcoming earnings report shows short iPhone X demand, this doesn’t mean that the company deserves a Sell rating. Apple is extremely profitable, has one-third of its value in cash, and trades at a very healthy P/E of 16.2. These are not common traits in today’s market. Let’s remember that Apple isn’t Tesla where news of troubling Model 3 production should lead to a big reaction. An iPhone X stumble won’t cause anywhere near the long-term pain that the sellers of Thursday and Friday believe.
Disclosure: I am/we are long AAPL, TSLA.
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.