Barclays Equity Research analysts Ben A. Reitzes, Ryan Jones and Matthew Markezin rate Apple Inc. (NASDAQ:AAPL) as overweight. Last night, China Mobile (covered by Anand Ramachandran) and Apple Inc. (NASDAQ:AAPL) announced a partnership for China Mobile Ltd. (NYSE:CHL) (HKG:0941) to carry the iPhone. Pre-orders will begin on Christmas Day on China Mobile’s official website. iPhones will be available through both Apple retail stores and through China Mobile retail stores starting January 17.
Apple Inc. (NASDAQ:AAPL) noted that that the phone will run on 4G/TD-LTE and 3G/TD-SCDMA – in line with consensus views. No pricing data has been announced as of this point but we believe that the phones will obviously retain a premium price. We believe this announcement is a relief given concerns after the absence of Apple Inc. (NASDAQ:AAPL) at China Mobile Ltd. (NYSE:CHL) (HKG:0941)’s Global Partnership Conference last week. Based on our checks, we believe the iPhone is poised for a moderate adoption rate in the near-term and the transaction should be supportive to our estimates for iPhone shipments in C1H14. We believe Apple is one of the few companies in our coverage that has the potential to grow within China in 2014.
Comfortable with Recent Checks and a More Gradual Take Rate in China
Given the timing of the announcement, we see no benefit to the current quarter but some potential for channel fill in the March and June quarters, in line with prior views. Also, even with a deal now official, we expect a gradual take rate given network limitations – and note that there are already 45 million iPhone users on the China Mobile Ltd. (NYSE:CHL) (HKG:0941) network. This figure seems to have grown by about 10 million over the last four months, helped by the iPhone 5S and perhaps increased sales of refurbished phones.
We believe that the ramp up of 4G will be gradual and iPhone sales may build over multiple quarters. Our colleague Anand Ramachandran (who covers China Mobile) believes Apple Inc. (NASDAQ:AAPL)’s total addressable market (TAM) within China Mobile could approximate 80 million units.
Given our checks in the supply chain and having already factored in the revenue guidance for the December quarter, we remain comfortable with our iPhone forecasts but don’t expect unit upside. For the December quarter, we forecast iPhone unit sales will be 55.0 million. We estimate a decrease in shipments in fiscal 2Q14, with iPhone units down 21% q/q to 43.2 million – a function of traditional seasonality.
We also believe upside is limited since units are likely to be heavily weighted to the 5S, as the 5C is not seeing strong demand at all (been obvious since launch). For full year FY14 we estimate iPhone unit sales will grow 15% y/y to 173.33. The work of our colleague, Kirk Yang (Asia ex-Japan IT Hardware), backs our estimates – with estimates of CY4Q13 iPhone builds of 54-56 million.
Given our checks in the supply chain and having already factored in the revenue guidance for the December quarter, we remain comfortable with our iPhone forecasts but don’t expect unit upside. For the December quarter, we forecast iPhone unit sales will be 55.0 million. We estimate a decrease in shipments in fiscal 2Q14, with iPhone units down 21% q/q to 43.2 million – a function of traditional seasonality.
We also believe upside is limited since units are likely to be heavily weighted to the 5S, as the 5C is not seeing strong demand at all (been obvious since launch). For full year FY14 we estimate iPhone unit sales will grow 15% y/y to 173.33. The work of our colleague, Kirk Yang (Asia ex-Japan IT Hardware), backs our estimates – with estimates of CY4Q13 iPhone builds of 54-56 million.
As for iPad, our estimates account for potential strength from the thinner iPad Air and refreshed iPad Mini with retina display. We estimate total iPad unit sales (combined iPad and Mini) will be up 78% q/q to 25.1 million units for the December quarter. For FY14, we also estimate that Apple will grow iPad units 16% y/y to 82.5 million. We note that iPad Mini constraints should last through the March quarter.
Given a lack of unit upside, we believe investors’ attention in the near term could turn to gross margin – and in Apple’s ability to increase buybacks this spring. Our estimate for gross margin of 37.2% in the December quarter (up 20bps q/q, recall that this guidance is impacted by a software revenue deferral) could have upside given very favorable product mix. In the March quarter, we estimate another 10bps of expansion sequentially to gross margins of 37.2%, which could also be quite conservative.
We believe the margin upside helps EPS and cash flow, while revenues may lack significant upside until new products hit in 2014. With profitability relatively stable and the balance sheet still strong, we believe the company is well positioned for an expanded stock repurchase program in the spring. On its last earnings call, Apple Inc. (NASDAQ:AAPL) also acknowledged it would review its current authorization in the spring and we believe there is still the potential for upside beyond the current $60 billion authorization.
Apple New Product Catalysts More Likely in 2H14
We continue to believe that Apple Inc. (NASDAQ:AAPL) will launch two larger-screened iPhones in 2HCY14, which could really help its demand in Asia with China Mobile Ltd. (NYSE:CHL) (HKG:0941) and other carriers. In a similar timeframe, we also believe that a 13” iPad makes sense, with a better keyboard accessory (see iPad Could Have a More Interesting Future in 64-Bit). We also believe there is an increased possibility of a wearables strategy emerging at Apple in 2014 and the technology for curved displays may be ready during the year.
However, we do not see evidence of a TV set yet in Apple Inc. (NASDAQ:AAPL)’s future, although it makes sense for the company to meaningfully update its services capabilities tied to Apple TV and iOS devices in 2014. All told, CY14 seems like a much better year for innovation and new products for Apple – but it may be quite 2H loaded. As a result, we believe near-term share price upside at Apple Inc. (NASDAQ:AAPL) may be driven more on the gross margin side – and in its ability to increase buybacks this spring.
