SIG analysts Chris Caso and Liz Pate examine the impending iPhone 6 from several angles, concluding that the new iPhone could solidify Apple’s position as well as that of its suppliers.

apple iphone 6

We expect the launch of iPhone 6 to be a catalyst for both Apple Inc. (NASDAQ:AAPL) and their supply chain when the device launches in mid-2014. We expect relative outperformance of a basket of AAPL and their supply chain (AAPL/BRCM/QCOM) vs. PC semis (INTC/AMD/NVDA).

iPhone 6 launch

We think the launch of a new iPhone 6 this year will be an important catalyst for the technology space, and represents our favorite investment theme of the year. A year ago, investors had begun to doubt Apple Inc. (NASDAQ:AAPL)’s hegemony within the mobile space, but the better than expected reception of iPhone 5S coupled with poor consumer reception of Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930)’s flagship phone has in our view increased Apple’s competitive advantage.

We think new features in iPhone 6 will serve as an important catalyst for both existing and new consumers to upgrade to this device. We recommend owning a basket of Apple Inc. (NASDAQ:AAPL) and its suppliers (including BRCM and QCOM) to participate in this catalyst. As a hedge, we recommend a basket of PC-related names (including INTC, AMD and NVDA), for which investors have recently regained optimism. We view this recent stabilization behind such optimism to be a head fake, since we don’t believe that anything has fundamentally changed to reverse PC’s longer-term decline.

iPhone 6 with larger screen and improved features

Larger screen and improved features create an upgrade catalyst for both existing iPhone users as well as new customers. Our thesis is fairly simple – that consumers have been waiting for a larger-screen iPhone for some time, and it will be an extremely important catalyst when it arrives. We were surprised by the strong consumer acceptance of iPhone 5S (which was a catalyst for our September AAPL upgrade), which we think reflects on the strength of Apple Inc. (NASDAQ:AAPL)’s ecosystem and the shortcomings in competitors’ high-end phones. But despite the success of the 5S, we think the lack of an option for a larger screen represents a competitive gap in Apple Inc. (NASDAQ:AAPL)’s lineup that we expect to be filled by iPhone 6. We expect this to be a catalyst for existing iPhone users to upgrade, and to attract some users from Android as well. Note that we also think it’s quite possible for Apple Inc. (NASDAQ:AAPL) to charge a premium (perhaps an additional $50-$100) on a larger-screen phone to avoid margin erosion due to the higher bill of materials cost.

BRCM and QCOM should experience higher dollar content from iPhone 6’s new features. The larger screen won’t be the only important feature we expect in the new iPhone, and some of these features will directly benefit two of Apple Inc. (NASDAQ:AAPL)’s largest suppliers, QUALCOMM, Inc. (NASDAQ:QCOM) and Broadcom Corporation (NASDAQ:BRCM). And both suppliers suffered from dollar content reductions in 2013 due to price reductions since key features were not upgraded on iPhone 5S. For QCOM, we expect higher dollar content on the cellular modem as we expect Apple Inc. (NASDAQ:AAPL) to migrate to the QCOM 9225 modem that supports LTE Advanced features, the most notable being carrier aggregation. For BRCM, we expect higher content from improved WLAN features. Namely, we expect iPhone 6 to support .11ac wireless with dual antennas, which will provide increased WiFi range and throughput speeds.

China Mobile catalyst controversial, but not in Street numbers

Our supply chain checks correctly identified the production planning for a China Mobile Ltd. (NYSE:CHL) (HKG:0941) iPhone at the end of last summer, and we do think it’s significant that iPhone is now offered at the world’s largest wireless operator. Now that the launch has occurred, we’ve noted significant investor skepticism about the unit potential at China Mobile. Bears argue that a number of iPhones already operate on China Mobile (on WiFi), and that the incremental opportunity for a highly priced phone is limited. But most importantly, we think Street estimates currently include very few China Mobile Ltd. (NYSE:CHL) (HKG:0941) units at present.

We believe Street expectations for C14 iPhone units are approximately 175 mln units. If one assumes only 10 mln incremental units for China Mobile (which we believe to be a conservative number), it would indicate only 5% Y/Y unit growth for iPhone units excluding China Mobile. Given that C14 should also benefit from the iPhone 6 cycle, we therefore conclude that either the Street has not included any significant impact from China Mobile Ltd. (NYSE:CHL) (HKG:0941) in their estimates, or includes just a modest impact from iPhone 6. Either way, we view consensus estimates as conservative.

AAPL new product category potential a wild card catalyst

Our current supply chain checks haven’t turned up any new Apple Inc. (NASDAQ:AAPL) product categories on the near-term production forecast, so we won’t use this note to predict AAPL’s newest product category. But the company has been clear that investors should expect both new products as well as new product categories in 2014. Will that new category be a watch, a TV product, a larger-screen device? We don’t know. But we do view the likelihood that the first “one more thing” since Steve Jobs passing will occur in 2014 as a call option for Apple Inc. (NASDAQ:AAPL)’s stock this year. And we think it’s equally likely that Apple Inc. (NASDAQ:AAPL)’s existing supply chain partners would also participate in and benefit from a new category to represent a call option for those stocks as well.

We view recent PC optimism to be a head fake – we think the trend toward lower price points is inevitable,and will continue to pressure semiconductor companies dependent on the PC. It’s now been a number of years that we have held a negative bias toward PC-related names, and we recognize this is no longer a unique viewpoint. But the recent stabilization in notebook unit production has driven new optimism in the PC space and its supply chain.

During our Asia trip last month, we identified that the PC supply chain would meet expectations for the first time in six quarters – clearly a change in tone requiring investor respect. But we’re not ready to carry that respect much farther than the very near term. And even despite the tone improvement in the channel, such improvement didn’t materialize on Intel Corporation (NASDAQ:INTC)’s recent earnings call, suggesting continuing difficult conditions among mainstream price points, which are the most impactful to results. In total, we don’t think anything has occurred to change the long-term trend.

We think that trend will drive lower system price points, and less dependence on Windows going forward. Both of these trends are negative for the incumbents in the PC supply chain, including Intel Corporation (NASDAQ:INTC), Advanced Micro Devices, Inc. (NYSE:AMD) and NVDA. In the case of INTC, lower system price points make it much more difficult for INTC to sell their high-priced mainstream CPUs. Since INTC’s CPU price is such a high percentage of the total cost, Intel Corporation (NASDAQ:INTC) simply can’t maintain pricing as system price points go lower. And on non-Windows devices, CPU prices are one-fourth

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