Apple Inc. (NASDAQ:AAPL) is scheduled to host WWDC 2013 on June 10 where analysts expect the focus to be placed on new Software releases (Mac OS and iOS 7) and highlight the developer community’s ability to monetize their Apps on Apple Inc. (NASDAQ:AAPL)’s platform.
Specific items analysts are looking for include: 1) an overhaul of the iOS user interface (impact of Jony Ive’s flat modernized look and feel), 2) iCloud updates 3) Siri refinements and 4) a Maps upgrade. Apple Inc. (NASDAQ:AAPL) will also likely provide a peek at new OSX features (borrowing from iOS touch interface and Apps).
While analysts at Deutsche Bank don’t anticipate any iOS hardware announcements at WWDC (perhaps new MacBooks), they believe initial component orders have started for long lead time parts in preparation for this fall’s iPhone launch. After WWDC, the big question marks facing Apple Inc. (NASDAQ:AAPL) include: 1) margin impact of the substantial product transitions on the Sept quarter, 2) the impact of a lower end iPhone on Apple’s overall revenue (ASP) and profitability and 3) whether a potential deal with China Mobile is consummated.
Deutsche Bank’s analysts note that Street expectations do not appear to be factoring much margin impact from multiple product transitions in the September Q and they see downside risk to Street GM expectations as a result (Street at 36.8% vs. DB at 34.5% in Sept and 37.7% vs. DB at 35.5% in Dec). That said, even on their more conservative margin expectations, Apple Inc. (NASDAQ:AAPL) trades at only 6.5x 2014 EV/FCF which still looks incredibly attractive given upside wildcards around iTV and iWearables.
Apple iOS 7 and Mac OS upgrades
Analysts believe iOS is due for a material upgrade in order to freshen and reinvigorate the ‘cool’ factor around Apple Inc. (NASDAQ:AAPL)’s products. The general look and feel of iOS is 6 years old and is in need of an update and some spark. It seems clear that Jony Ive’s fingerprints will be all over iOS 7, which analysts expect to be the most significant iOS upgrade from a visual perspective. Beyond an overhaul of iOS cosmetics, they expect updates to Passbook (as a precursor to mobile payments / fingerprint sensor authentication) and incremental improvements to Maps, Siri and iCloud.
In addition, Apple Inc. (NASDAQ:AAPL) may preview new OSX features; borrowing from the iOS touch interface and Apps and driving greater cross fertilization of the user experience across both environments. Overall, analysts from Deutsche Bank do not expect the software refresh to be a major catalyst for Apple Inc. (NASDAQ:AAPL) shares. Rather, they expect the series of upcoming hardware cycles beginning this Fall to drive a growth re-acceleration and reinvigorate Apple’s brand.
While analysts don’t anticipate any meaningful iOS hardware announcements at WWDC, the research firm’s checks indicate orders for the new iPhone are starting now for longer lead-time components. Specifically, they believe Apple Inc. (NASDAQ:AAPL) is currently placing component orders for iPhone volume manufacturing to ramp in the August time-frame, suggesting they’re on pace for a late September launch. After WWDC, analysts expect question marks around 1) margins in the transition quarter, 2) the impact of a lower end iPhone on Apple Inc. (NASDAQ:AAPL)’s overall profitability and 3) a China Mobile deal to come into focus.
Apple margins in past product transitions
Apple Inc. (NASDAQ:AAPL) typically experiences a sequential margin dip as it navigates major iPhone transitions. In each of the last 3 iPhone transitions, Apple Inc. (NASDAQ:AAPL)’s consolidated gross margin has declined by an average of ~2 ppts Q/Q in the transition quarter. For example, the iPhone 4 to iPhone 4S transition (which is most similar to the 5 to 5S transition), Apple Inc. (NASDAQ:AAPL)’s total gross margin slid from 41.7% to 40.3% Q/Q. The firm would expect a similar Q/Q drop in margins with the iPhone 5 to 5S transition in isolation.
What is unique in this cycle however, will be the introduction of a new lower-priced iPhone, which creates additional operational risk (around manufacturing cost ramps) and likely carries lower margins, creating the potential for a negative mix shift. In addition, analysts expect the new iPhones to ship in late September and therefore will only be available for a limited period within the quarter. As a result, lower fixed cost absorption (resulting from the work-down of old iPhone channel inventory) and ramp up of new products could be greater than in past years as the product line transitions.
Despite these issues, Street expectations do not appear to be factoring much of a margin impact from the upcoming iPhone transition. As a result, analysts from DB see risk to near-term Street gross margin expectations of 36.8% (vs. DB at 34.5%) in September and 37.7% in December (vs. DB at 35.5%).
Apple’s Stock Valuation
Despite analysts concern that near-term margin expectations appear high, the stock remains attractively priced, particularly considering Apple Inc. (NASDAQ:AAPL)’s substantial capital return program. On an EV/FCF basis, Apple Inc. (NASDAQ:AAPL) trades in line or at a discount to other more traditional hardware companies, despite having much stronger growth prospects over the medium-term. In addition, The research firm’s Apple Inc. (NASDAQ:AAPL) estimates do not include any contribution from future new products like iWearables or iTV. As a result DB maintain its Buy rating, but note some risk to near-term expectations.