Apple Inc (AAPL) Margin Story is Replica of Q4 2010: Deutsche Bank

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Apple Inc (AAPL) Margin Story is Replica of Q4 2010: Deutsche Bank

We wrote an article on Thursday regarding concerns over Apple’s gross margins. Apple’s gross margin guidance disappointed investors last week as most analysts  under-estimated the incremental costs of ramping Apple’s broad new product refresh. Apple expects overall corporate gross margins to decline 400 basis points Q/Q to 36% from the 40% just reported. Deutsche Bank analysts are out with some interesting research, which attempts to refute the argument that Apple will have lower gross margins going forward.

However, Deutsche Bank believes this step down in margins is nearly entirely cyclical and not structural. Additionally, this margin step down is not without precedence.

They note is a striking parallel between Apple’s margin outlook for the iPhone 5 ramp and the prior iPhone 4 cycle- which was the last complete iPhone overhaul (i.e. form factor and manufacturing process). As depicted in the graph below, Apple’s overall margins  stepped down momentarily after the launch of iPhone 4 until reaching new highs approximately four quarters following its release.

They suspect a similar margin dynamic will evolve for iPhone 5 as it ramps to full volume production over the next 3-6
months. Their estimates imply that Apple’s iPhone margins recover roughly half of the anticipated peak-to-trough drop associated with the iPhone 5 ramp.

In the quarter following the iPhone 4 release, Apple Inc. (NASDAQ:AAPL) guided GM’s to ~35% and Apple’s CFO cited margin pressure due to “to a higher mix of iPhone 4 and iPad sales, which have higher cost structures…” And, as depicted in Figure 4, Apple experienced a step down in gross margins in the quarter these products ramped.

Similarly, last week Apple Inc. (NASDAQ:AAPL) guided GM’s to 36% and cited the broad product refresh (approximately 80% of revs – iPhone, iPad, Macs and iPods) in saying “…these products have higher costs than their predecessors and therefore lower gross margins.”

As the iPhone 4 cycle ramped, Apple Inc. (NASDAQ:AAPL)’s gross margins took a step down from approximately 39% in June 2010 Q to to ~37% in September but increased in all subsequent Qs to ~42% in June ‘11 (ahead of the iPhone 4S refresh). While AAPL does not disclose gross margins by product line, Deutsche Bank estimates that iPhone margins increased from ~47% to ~55% over the same time frame.

There are two key points resulting from this analysis:

1) GM’s dipped for a single quarter in the iPhone 4 cycle which Deutsche believes is comparable to the iPhone 5 cycle

2) Apple Inc. (NASDAQ:AAPL) typically beat its own margin guidance by 2-4ppts (averaging 2.3ppts); suggesting there is a healthy amount of conservatism in Apple’s F1Q13 margin guidance.

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