Of the many concerns about Apple’s business, one of the biggest is that its margins are going to collapse as the smartphone business becomes commoditized.
Apple analyst Gene Munster confirms that Apple’s margins are due for a big drop. And he also basically confirms its going to be due to smartphone competition.
In a new note, he’s calling for Apple’s margins to be at 34% in two years. He believes Apple’s low-margin “cheap” iPhone, which Apple would release to chase market share, is going to hit the margins.
The consensus from analysts is for Apple’s margins to be 37% in two years, which means that if Munster is right, investors are in for a surprise.
He says there are murmurs of Apple’s gross margin going sub 30%, which would be a disaster. Munster thinks it would take “a nuclear meltdown” in Apple’s model for the margins to go lower than his estimate. The nuclear meltdown would happen if Apple released a cheap iPhone that took 50% of the overall iPhone mix and if it release a super low-margin TV.
The good news is that Munster looked at the iPhone business and concluded that its margin has remained stable, which is counter to what many people believe since a year ago Apple’s margin was 47.4%. Last quarter it was 37.5%.
The iPad Mini caused the drastic fall in Apple’s margin, says Munster. He believes it has a 20% margin, while the iPhone has a 55% margin. If you back out the iPad Mini, Apple’s overall margin would have been 40.2% last quarter.
Obviously, you can’t back out the iPad Mini. Further, Apple is expected to release a cheap iPhone, which he thinks could have a margin similar to the iPad Mini.
He doesn’t include an Apple TV in his model, but if Apple does release a TV, he sees it with a 10%-20% margin.
The cheap iPhone, the iPad Mini, and the television would all cause a serious drag on Apple’s margins.
This is all largely speculative, so you should treat it as such. But, Munster lowered his price target on Apple to $655 from $688 after lowering his EPS estimate for next year by 5%.
Here’s two tables from Munster that lay out various EPS scenarios based on the low-cost iPhone and TV.