Morgan Stanley Says iPhone Demand Is Off The Charts

Image representing Steve Jobs as depicted in C...
Image via CrunchBase


Apple’s stock has been crushed since the end of September when it closed above $700 for the first time ever. 

On Friday it closed at $509.79, a new low in this slump.

As Apple’s stock has fallen, analysts have slowly started dialing back expectations. Jefferies, UBS, and tonight, Citi, all cut their price targets on the stock.

All three are cutting for basically the same reason — Asian suppliers say Apple cut its orders for the iPhone 5 in the first quarter of the year. This suggests demand for the iPhone is not fantastic, though it’s probably still good. The other reason is that the iPad Mini is eating into sales of the full sized iPad.

Morgan Stanley analyst Katy Huberty is out with a note knocking down both of those theories. Here’s the key takeaways from her note:

  • There is “strong demand” for the iPhone 5. “Importantly, a greater percentage of consumers plan to purchase the higher priced iPhone 5 as compared to iPhone 4S mix a year ago. As a result, we see potential upside to both our 50M unit (+35% Y/Y) and $642 (-4%) ASP assumptions in C4Q.”
  • The iPad is doing better than you think against the iPad Mini. “Forty-seven percent of iPad mini purchases are to new customers, only slightly lower than the 56% for iPad 9.7” suggesting cannibalization risk is manageable.”
  • Apple is “holding its own against Samsung.” Samsung’s success isn’t coming at the expense of Apple, rather at expanse of other Android phone makers.

Of all of these, the most shocking is the idea of beating 50 million iPhones sold this quarter. If Apple hits 50 million or above, it will silence many of the skeptics.

Apple stock fell Friday to $ 510

That’s the lowest close for the stock since its recent swoon began in September.

(It’s also a level that Apple first breached on the way up last winter. The stock is still up sharply this year, having entered the year at about $400.)

What’s going on?

Several things.

Some are fundamental, having to do with changes in Apple’s business.

Others are market-related (tax-related selling is likely having a significant impact).

Still others related to sentiment.

Here are some of the issues:

  • First, in news today, Apple has reportedly slashed its orders for iPhones for the first quarter of next year. According to UBS and other sources, Apple cut its “build” orders from 35-40 million units to 25-30 million. This suggests that sales of the all-important iPhone may be far lower than Wall Street has been expecting. It also suggests that the iPhone 5 has not been the colossal hit that Apple needed it to be.
  • More broadly, Apple has been a monster of a stock for the last decade, and some investors are likely taking the opportunity to lock in these gains while paying today’s low capital-gains tax rates. Whatever deal the government finally arrives at with regard to the Fiscal Cliff (if any), it will likely include a hike in the capital gains rate.
  • Apple recently shot its wad from a product-launch perspective, and analysts aren’t expecting anything truly exciting to happen until next summer at the earliest. That gives short-term investors little reason to hang on to the stock.
  • Apple’s amazingly high profit margin is likely to decline over the next several years, as Apple’s product mix shifts toward lower-margin tablets from the high-margin iPhone and the iPhone margin itself declines with the introduction of lower-priced phones. This suggests that earnings are likely to grow more slowly than revenue, in contrast to the situation for the past 5 years.
  • Apple’s next revolutionary new product–a TV or TV device of some sort–appears to have been postponed by a year. Analysts are also not sure what this product will be and how it will sell. Dozens of companies have tried to reinvent TV over the last 15 years, and almost all of them have failed. Apple also appears to have met resistance from the TV industry, which will do everything it can to preserve the status quo.
  • Apple’s competitors are catching up in both smartphones and tablets, so Apple no longer has the leverage with distributors and consumers that it once did. This, too, could eventually lead to more margin pressure.
  • Lastly, Apple really is finally entering the “post-Steve Jobs” era, and it remains to be seen how successful the company’s next generation of products will be.

All of these factors are likely weighing on Apple’s stock.

But here’s the good news:

The stock is cheap.

Apple is now trading at 12X trailing earnings per share.

That’s not screamingly cheap. In the old days (mid-1990s and earlier), hardware stocks used to trade between 8X-12X earnings, and Dell, HP, and other companies are now trading there again.

Unlike HP, Dell, et al, Apple is still a very healthy company, so if Apple ever gets to 8X earnings, it will be screamingly cheap.

But at 12X earnings, Apple is at least reasonably cheap–cheaper, for example, than the stock market as a whole.

And Apple also has $125 billion of cash.

Factor out that cash, and the business itself is actually getting close to trading at the Dell and HP level.

CHINA Sales – Not So HOT

Apple shares fell 3.9% in early trading on Friday after the launch of its iPhone 5 received a frosty reception in China, and two analysts cut shipment forecasts.

It was a dramatic contrast to the scenes at the iPhone 4S launch in January when an angry crowd pelted the store in Beijing with eggs and fights broke out between would-be touts aiming to resell new phones.

On Friday there was one person waiting at Apple’s store in Shanghai’s financial district before it opened. But the lack of queues may have been down to the online lottery scheme introduced by Apple to prevent a repeat of January’s chaos. It used the same method earlier this month for the launch of its iPad mini, and enforced a two-per-person limit.

Although the company has 300,000 pre-orders for the phone from China Unicom, one of the three big mobile providers, and will also sell it through mobile company China Telecom, it has still not sealed a deal with China Mobile, the biggest player with 703 million users of whom 79m are 3G (ie smartphone) users. Despite years of talks, the two sides have disagreed on revenue splits and business models.

That means Apple is unable to increase its shipments there as fast as the market for smartphones is growing. There are already 290 million smartphone users and that is forecast to double in the next 12 months.

Nokia’s shares rose earlier this month after it tied up a deal to sell its Lumia smartphones through China Mobile.

Even so, China Mobile announced in March that an estimated 15 million people use iPhones on its network, despite their being incompatible with its data services.

More broadly, But Apple and Nokia are struggling in the face of competition from devices powered by versions of Google’s Android software: those make up roughly 90% of the smartphones sold in China, although many connect to Chinese services rather than Google’s.

“In absolute terms, this (iPhone 5) launch will certainly result in strong sales for Apple in China. However, in relative terms, I don’t believe it will move the needle enough in market share,” Shiv Putcha, a Mumbai-based analyst at Ovum, a global technology consultant, told the Reuters news agency.

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