Wells Fargo analyst Maynard Um may see a positive future for Apple, but that isn't stopping him from downgrading the company's stock from "Outperform" to "Market Perform" over concerns about its gross margins in 2014. His concern is that Apple's gross margin will see pressure thanks to the iPhone 6 and a power shift from handset makers back to cell service providers.
Wells Fargo sees lower groos margins for Apple with iPhone 6 launch
Mr. Um told investors,
While we still have conviction in the gross margin thesis (and the potential for iPad/iPhone unit upside), we believe this may be largely embedded into the valuation. From a positive catalyst perspective, we expect 2014 to be highlighted by new products (iPhone 6, iWatch, iBeacon) and an increase in dividends and/or share repurchases. However, we're concerned that 1) [gross margin] will come under pressure later this year in the iPhone 6 cycle, 2) there is limited amount of incremental market cap opportunity in the existing product segments Apple plays in (including the TV and watch opportunities) without material market share gains, and 3) the balance of power may start to shift back to wireless operators from handset vendors.
He said that Apple's gross margins show a consistent decrease of about 225bps when the company releases a new form factor iPhone like the iPhone 4 and iPhone 5, but increase by about the same amount when the "S" versions -- the iPhone 4S and iPhone 5S -- ship.
Carriers will likely start cutting back on subsidized pricing where market penetration is high, like in the United States. Instead, he sees carriers pushing services that drive usage which could scale back the number of smartphones sold. As a result, carriers will have a stronger position in the smartphone market compared to device makers, including Apple.
Concerns over what may happen to Apple's margins after the next iPhone launch, however, don't have Mr. Um worried about the just ended holiday sales period. He expects Apple will report strong quarterly iPhone, iPad Air, and iPad mini sales saying, "We forecast 24 million iPads and 54.8 million iPhones and note that every 5 million iPads equates to $0.37 in EPS and 5 million iPhones $1.10, all else equal."
Looking forward, Mr. Um does see Apple's product mix as a strength for the company with new devices in 2014 driving continued interest.
Mr. Um's "Market Perform" rating comes with a US$536 to $581 valuation range. Apple is currently trading at $553.96, down 7.06 (1.26%).