Apple Inc. (NASDAQ:AAPL)’s gross margin is in decline. The company’s supporters have argued that the problem is short term, owing to the release of the iPad Mini and higher capital expenditure. That’s not the whole truth. Both of those things play into the company’s gross margin problems, but there is a single source of the problem. A lower gross margin is the cost of staying competitive. It’s a tax that Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930) levies on Apple Inc. (NASDAQ:AAPL).
A new report from Bernstein analyst Toni Sacconaghi takes a look at Apple Inc. (NASDAQ:AAPL) gross margins and comes to that exact conclusion. The analysis is not entirely negative on Apple Inc. (NASDAQ:AAPL), despite the grim lessons on gross margin it contains. Bernstein puts a price target of $600 on the company and maintains its Outperform rating on the company.
Apple gross margin decline
Investors and analysts have been following gross margin decline at Apple Inc. (NASDAQ:AAPL) for some time. The metric was supposed to improve appreciably with the release of the iPhone 5s because gross margin usually rises on the release of a half-generation iPhone. Gross margin rose for the company, but not enough to impress the market.
The causes of the decline in gross margin are many, but two stand out. Apple Inc. (NASDAQ:AAPL) may not own many factories, but its capital expenditure has jumped from $2 billion in 2010 to more than $8 billion in 2013. At the same time warranty accruals have risen from $900 million in 2010 to $5 billion in 2013. These numbers are not likely to get smaller in the years to come. Apple Inc. (NASDAQ:AAPL)’s gross margin is not likely to hit 2012 levels again.
Gross margin decline is a problem for Apple Inc. (NASDAQ:AAPL) shareholders. Many explain it away by presenting it as a temporary problem, or one not likely to get worse in the medium term. The Bernstein report does not agree with that stance. Apple Inc. (NASDAQ:AAPL)’s gross margin is a Samsung tax.
Apple Samsung tax
The key line of this report reads, “While some investors argue that normalizing Apple Inc. (NASDAQ:AAPL)’s GMs for rising depreciation and warranty accruals is appropriate to see Apple Inc. (NASDAQ:AAPL)’s true gross margin trend, we disagree – increases in both cap ex and warranty reflect the increased cost of doing business and remaining competitive, and should be included when examining Apple Inc. (NASDAQ:AAPL)’s cost structure.”
The causes of the decline in Apple Inc. (NASDAQ:AAPL) gross margin are not one off, nor are they unrelated to the rest of the business. They are part of the company’s attempts to compete with firms like Samsung. The lower gross margin at Apple Inc. (NASDAQ:AAPL) is a tax that Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930) levies on the company. It’s not going away any time soon, and investors should get used to it.
Despite the lower gross margin, which the Bernstein analyst don’t expect to recover, Apple Inc. (NASDAQ:AAPL) is still a strong company. There are a couple of strong upside catalysts, including a China Mobile Ltd. (NYSE:CHL) deal and a new product release, that might raise the price of the stock in the coming year. That leaves the analysts optimistic even in the face of the Samsung tax.