Apple: “There is upside to gross margins” (UBS)

UBS analysts released their comments on Apple stock on Tuesday ahead of the company’s results report:

The combination of this quarter’s Apple buyer survey and our detailed model leads us to conclude that there is upside to gross margins both near- and intermediate-term. We have tweaked our estimates higher and are above consensus. Both iPhone and iPad product mix should shift up and support ASPs. The stock could trade back near a market multiple as it did in 2012.

Gross margin upside in F2015

Our proprietary bottoms-up Apple model suggests there is upside to the Street’s gross margin assumptions in 2015. We have increased our F15 EPS estimate by 6% to $7.63 due to an increase in our gross margin expectation from 36.6% to 38.1%. Factors supporting a strong gross margin include (1) the waning of pressure from the step-up in deferred revenue along with lower warranty expense; (2) better fixed cost absorption than when the iPhone 5 was introduced; (3) a strong mix within iPhone, limiting gross margin deterioration; and (4) potential for an iWatch gross margin of 40% or better.

CIRP survey shows positive mix shift in June quarter

CIRP’s quarterly US Apple buyer survey indicates there may be margin upside in the June quarter based on product mix. The survey finds that (1) the 5s had a stronger contribution than did the iPhone 5 a year ago; (2) average iPhone storage increased in the June quarter whereas it typically declines; and (3) the iPad mix shift to the mini has reversed due to the success of the iPad Air. There also are positive demand factors: (1) a higher portion of recent model iPhone owners appear to be waiting for new models than a year ago, and (2) more Android users are switching to Apple.

Valuation: Buy and raising price target to $115

We are raising our price target from $100 to $115 based on slightly higher estimates and an expanding multiple. We expect Apple’s current P/E discount of 13% to narrow as earnings outgrow the market rate. Our target of $115 is based on an F15E P/E multiple of 15x or 12x when excluding $25 cash per share. On an EV/FCF basis, our target would be 9.5x our F15 FCF estimate of $54.5bn.

 

*You can read the full report here.

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