Apple Inc. (AAPL) Downgraded Ahead Of Q1 Earnings

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BGC Partners analyst Colin W. Gillis downgrades Apple Inc. (NASDAQ:AAPL) from Buy to Hold as the stock performance is expected to track more in line with the broader market index.

The risks seem balanced, to the upside and downside, with good news priced in.

Shares of Apple have produced a total return (dividends reinvested) of 42.5% since our upgrade on April 22, 2013 compared to a total return of the S&P500 index of 16.4% (dividends reinvested). We are reducing our rating to HOLD from BUY as the stock has reached our $550 price target and we expect the performance of the stock to track more in line with the broader market index.

What about the Record Holiday Quarter?

We expect Apple Inc. (NASDAQ:AAPL) to post an astounding quarter with over 80 million iOS units sold, powered by the view that the company makes the best products in the space. That said, we see that the market has already broadly anticipated a record quarter, and the upside risks seem balanced with downside risks in our view. Yes, we could be giving away some upside on the reaction to the December quarter print, particularly if the company can ship 57-60 million iPhones or produce results with revenue and EPS around $60 billion and $15. That said, we see that expectations are again possibly overheating, particularly with regard to the opportunity with China Mobile.

Additionally the market dynamic where the functionality gap between products is closing, while the price gap is widening remains an issue for Apple Inc. (NASDAQ:AAPL). Broadly speaking, the next 1 billion people purchasing smartphones are going to be from demographics less wealthy than the first billion, and the skew towards lower priced hardware is likely to continue. We do not suggest that Apple, as a high-end brand, needs to chase after the low-end market, but we do suggest that the company introduce new products to its customer base.

Apple’s Wearables, Beacons, Payments, TVs

We remain positive on Apple Inc. (NASDAQ:AAPL)’s ability to introduce wearable products that target the quantified self, a market we see as a natural fit to the Apple customer base. We are also positive on the potential for beacons and payments. We appreciate the concept of ultra-high definition TVs, and the streaming potential for associated content from iTunes, but caution this type of product may capture less than the 10% market share suggested by certain investors in a recent SEC filing.

Apple lagging in critical areas

It is also worth mentioning that one can argue that Apple Inc. (NASDAQ:AAPL) is lagging in critical areas, with high profile wearable products from competitors already on the market such as Glass, inexpensive products such as Chromecast linking tablets/phones/PCs to TVs, and Apple’s approximately 575 million credit cards associated with iTunes an underutilized asset as it is not being broadly used for other payments.

Apple’s valuation

While we appreciate that Apple Inc. (NASDAQ:AAPL)’s shares may look appealing from a ratio perspective, trading at 12.3x our FY2014 earnings estimate, we mention again that earnings of companies in a fast moving technology landscape can change quickly. Apple remains that largest capitalized company on a U.S. listed exchange with its $493B valuation and as such we see the company as also being subject to selling for reasons outside of its fundamentals such as cash liquidation needs.

Company guidance and balance sheet

Company guidance for the December quarter is $55-$58B in revenue, gross margin of 36.5-37.5%, tax rate to be 26.25%, other income/(expense) of $200M and operating expense of $4.4-$4.5B.

Balance Sheet: Apple Inc. (NASDAQ:AAPL)has $146.7B in cash ($161.40 / share) and $17B long-term debt as of September 30, 2013.

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