Friday, February 26, 2010

Apple, Inc. Product Catalysts Ahead; Reiterate Overweight

Product Catalysts Ahead;Reiterate Overweight

Impact on our views: The combination of attractive valuation (15.3x CY10 EPS), recent negative sentiment post the iPad announcement, and upcoming product catalysts set up for AAPL shares to outperform nearterm. Specifically, we think the March iPad launch and rising anticipation of the next generation iPhones will positively shift investor sentiment in coming months.

Longer term, we continue to believe the earnings power of the iPhone ecosystem is underappreciated. We reiterate our Overweight rating and $250 price target.

Catalyst 1: iPad launch in March: We expect Apple to ship its first iPad and announce additional content deals in late March to better than expected demand. We see the iPad targeting the sub-$800 consumer notebook market which equates to 30M annual units just in the US (120M globally). We expect iPad points of distribution to expand through CY10, both in the US and International markets, which could add 500K-1M units from channel fill alone. We forecast 6M iPad shipments in CY10, above the consensus view of 3-4M.

Catalyst 2: New iPhone product cycle in June: We expect Apple to launch new iPhones in June that offer both a lower total cost of ownership and new functionality, potentially including gesture-based technology. As we’ve highlighted in the past, the cost of device + service plan is currently the biggest barrier to incremental demand in both mature markets like the US and emerging markets like China (see Exhibit 1).

Where we could be wrong/early: The combination of seasonally weak C1Q demand and inventory draw down ahead of the new iPhone product launch have raised concerns about near-term iPhone shipments. It’s important to note that Int’l markets are a growing mix of iPhone sales (56% to 65% in LTM). With additional carrier launches in the UK and momentum/market share gains across Western Europe and Asia, we believe US iPhone units could drop below 2M (down 35%+ QoQ) without falling below the current 6.5-7M unit expectation.

Potential Catalysts
•iPhone exclusivity expiration announcements in the US, Germany, Spain and Japan
• New iPod/Mac product introductions including the ramp of Apple’s recently announced iPad
• Further reductions in iPhone total cost of ownership (hardware or service plan cost)
• Potential new content revenue streams, including books, magazines, video

Investment Risks
• Pricing and gross margin pressure if carriers pushback on high iPhone
subsidies in the face of exclusivity expirations, competition, and
network congestion
• Increased competition in the Smartphone market from android
based devices, RIMM, Palm, etc

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Apple, Inc. Product Catalysts Ahead; Reiterate Overweight

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