How Scary Are Apple's iPhone Cuts?

This sounds downright terrifying for Apple (NASDAQ: AAPL  ) investors, doesn't it? "Apple has cut its orders for components for the iPhone 5 due to weaker-than-expected demand," says the venerable Wall Street Journal. The report echoes one from Japan's Nikkei news service (via MarketWatch).

That does sound frightening and investors are indeed quite frightened. Shares dipped to as low as $497 in pre-market trading following the report, which was posted late Sunday night. During the regular session, shares were down nearly $22, or over 4.1%.

Let's dig into this rumbling and see if it has any legs. Is there real cause for concern?

Stop me if you've heard this one before
This news isn't actually news at all, as exactly one month ago Jefferies analyst Peter Misek noted that Apple component suppliers had received order cuts. Numerous other Street analysts have been adjusting their estimates downward over the past couple of months, in part due to these order cuts that have already made the rounds.

Display vendors Sharp, Japan Display, and LG Display (NYSE: LPL  ) , which source the iPhone 5's display, have supposedly been hit with order reductions. Combined, the three vendors were reportedly set to build 65 million iPhone displays for the current quarter, a figure that's now half of what it was.

Too much, too fast
When someone's bluffing in poker, a common tell is that they bet too much and too fast. This 65 million figure is nothing short of astronomical to begin with. Apple is expected to ship between 45 million and 50 million iPhone units in the fourth quarter, so building 65 million units for the following quarter would represent a sequential increase of 44% and 30%, respectively. That's absurd.

The fourth quarter is the big money maker, and no one should expect Apple to follow up a monster fourth quarter with an even monster-er first quarter. For context, this is how tall of an order that would be to fill relative to prior first-quarter shipments.

Source: SEC filings. Calendar quarters shown.

Apple has managed to post a sequential increase coming into the first quarter only once before in 2011. All other times the company has expectedly declined sequentially along with just about every other consumer-oriented manufacturer.

Metric

Q1 2008

Q1 2009

Q1 2010

Q1 2011

Q1 2012

Sequential iPhone unit change

(26.4%)

(13.1%)

0.2%

14.9%

(5.3%)

Source: SEC filings. Calendar quarters shown.

No one would ever expect Apple to sell 65 million units in the first quarter, given it's a seasonally slow time frame and Apple already rolled out the new device to virtually all of its carriers in the fourth quarter.

The weakest link
The displays were initially pegged as one of the primary bottlenecks when the iPhone 5 launched, with the other one being the aluminum unibody assembly. Misek's initial report believed assembly orders to be unchanged. Assuming all of these reports are interrelated, which they appear to be, that may simply mean Apple ordered too many of certain components and is reducing them as another bottlenecks production.

Apple's supply chain is a living, breathing entity with a lot of moving parts. I wouldn't purport to know more than Tim Cook about how all those pieces fit together, and neither should the WSJ, Nikkei, or investors.

The first 150 days
There's been some chatter that Apple may be shortening its product cycles, which coincides with the surprise release of the fourth-generation iPad late last year. Topeka Capital Markets analyst Brian White believes that both the iPhone and iPad will see speedy releases this year. White believes a fifth-generation iPad and second-generation iPad Mini are due out in March -- just five months after the last update.

He also believes new iPhones will be launched over the summer between May and June, including new configurations and choices regarding display sizes and colors. That's just four to five months from now.

As it turns out, many of Apple's component orders actually cover what the company thinks it will need for the next five months (according to its 10-K):

The Company must order components for its products and build inventory in advance of product announcements and shipments. Consistent with industry practice, components are normally acquired through a combination of purchase orders, supplier contracts, open orders and, where appropriate, inventory component prepayments, in each case based on projected demand. Such purchase commitments typically cover forecasted component and manufacturing requirements for periods up to 150 days.

Apple's manufacturing and component purchase commitments have skyrocketed to a whopping $21.1 billion as of September. If the company is indeed preparing to launch a new iPhone family, it could be preparing to ramp down 4-inch displays for the iPhone 5 in advance of ramping up smaller and/or larger iPhone displays over the next five months.

Who's coming with me?
Apple supplier plays are similarly dropping today. Cirrus Logic (NASDAQ: CRUS  ) is taking a beating today, down 8% at the low, as Apple continues to comprise the majority of its audio codec business, for better or for worse. Today, that's worse.

Qualcomm (NASDAQ: QCOM  ) was faring better than other suppliers, down "only" 1.5%. That's fair because the baseband modems it sells to Apple are a relatively smaller part of its business than some of its Apple supplying peers.

Some of the rampant fear today is misplaced, since the report is mostly recirculating what's already been noticed on the Street. It's quite possible that Apple is reducing orders, but the "weaker-than-expected demand" part is highly debatable. Competitive fears have been mounting lately, particularly from Samsung, which expects to post record operating profits in the fourth quarter. Want to know who else is expecting to post record sales in the fourth quarter?

Apple.

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Read/Post Comments (23) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 14, 2013, at 1:36 PM, jdmeck wrote:

    What iPhone cuts? Maybe you should get some facts first!

  • Report this Comment On January 14, 2013, at 1:40 PM, dwilh51183 wrote:

    THERE'S NOTHING WRONG WITH APPLE PEOPLE! USE YOUR BRAINS YOU CAN FIGURE THIS OUT. THEY SOLD 5 MILLION IPHONE 5'S THE FIRST WEEK ,THEY SOLD 3 MILLION IN THREE DAYS IN CHINA ...THAT IS 8 MILLION SOLD, plus we know 51 million iPhones were activated from Thanksgiving until Christmas which means Apple has a 53% market share which means that's another 28 million iPhones sold 28+5+3 is 36 million but that's only 5 weeks of the quarter. leaving 4 more weeks to sell a lot in 98 more countries

  • Report this Comment On January 14, 2013, at 1:40 PM, dwilh51183 wrote:

    Sacconaghi said he was maintaining his outperform rating and a $750 price target on the shares. That was because in the longer term, Apple offered “a compelling combination of attractive growth, reasonable price, and significant future option value.”He added that the company was also due for a dividend raise this year, another factor in its favor: “We believe that Apple’s announcement of a dividend in early 2012 was a significant catalyst for the stock, and that the company ought to consider raising its dividend this year, and potentially taking on debt to do so.”

  • Report this Comment On January 14, 2013, at 1:42 PM, dwilh51183 wrote:

    Though the decline has been severe (and the corporate news negative), Apple is in an amazing position to profit from two of the fastest trends in hardware technology.

Despite the recent depreciation in stock value, the company stands to clean up from two of the biggest trends in technology – tablets and smart phones. Data presented by Barron’s showed that smart phones have clobbered PC growth since 2008. Also, unit total and total value of smart phone sales eclipsed that for PCs for the first time last year.

    There’s no doubt the “smart phone revolution” stemmed from Apple, which sold more than 39.9 million iPhones in 2010. Apple increased that amount to 72 million units in 2011 and nearly 125 million iPhones during 2012.

In addition to being the king of smart phones, Apple holds the crown in the tablet market – a segment that may overtake PCs soon. Though tablets arrived late to the party, 100 million of them shipped last year (PCs were below 400 million units). In fact, Apple alone has sold more than 100 million iPad tablet devices during the past two years.

Amazingly, Apple recorded $156 billion in sales last year. iPhone- and iPad-related products accounted for $112 billion of that total amount.

The future direction of smart phones and tablets is obvious. And Apple is one of the few companies in a position to profit from that expected growth. The stock may move lower or wiggle around $515 for another few weeks or months. However, the company is in too good a position and the shares are too cheap to stay this low for an extended period.

  • Report this Comment On January 14, 2013, at 2:02 PM, applefan1 wrote:

    Can we get some more specifics on these so-called parts cuts? Actual details would be nice.

  • Report this Comment On January 14, 2013, at 4:35 PM, Darwood11 wrote:

    According to IDC, Apple held 14.6% of world-wide smartphone shipments in the third quarter. This is a decrease from the peak 23% in the fourth quarter of 2011 and first quarter of 2012.

    It's been estimated that Apple sold 50 million iPhones in the most recent quarter.

    That's a good number. However, the reported order cuts indicate that Apple expects a flattening of the "iPhone Units" curve that's included in this article.

  • Report this Comment On January 14, 2013, at 6:36 PM, mjrkong wrote:

    "Display vendors Sharp, Japan Display, and LG which source the iPhone 5's display, have supposedly been hit with order reductions."

    I'm thinking this is true. Not due to weak demand for iPhone 5 but on back of Apple switching LCD screens from the above 3 co's production of "in-cell" tech displays to new 'On Touch' technology. The co's involved with 'On Touch' will be TPK Taiwan, Innolux and AU Optronics. Hence, as the "in-cell" experiment comes to an end it is logical for LG, Sharp to see their orders cut to make room for the new displays.

  • Report this Comment On January 14, 2013, at 6:42 PM, mispoken wrote:

    I like turtles

  • Report this Comment On January 14, 2013, at 7:20 PM, JohnCLeven wrote:

    I think mispoken really hit the nail on the head.

  • Report this Comment On January 14, 2013, at 7:27 PM, RichSachen wrote:

    The recent news about Apples supply chain cuts could be just a result of realistic management as implied above. It could also be the first sign of a company that is coasting on past success.

    Apple relied on Steve Jobs to develop disruptive technology and had a team that produced results. Timothy Cook is cut from a similar mold, but isn't Jobs.

    That said, the first signs from Apple show a company that's coasting. The recent news out of Apple is about updates to current products or line extensions. Nothing new on the scale of the iPod, iPhone, or iPad. There have also been missteps in execution - iPhone glare and inaccurate iMaps to name a couple. A company who sells product at a premium because "It Just Works" can't have many more of those before the brand looses its meaning.

    Apple may bounce back, but I think there's still room for it to go down a bit more before they turn things around.

  • Report this Comment On January 14, 2013, at 7:59 PM, PSU69 wrote:

    Droid.

  • Report this Comment On January 14, 2013, at 9:28 PM, perpetuitas wrote:

    The Fool, along with MarketPlace from APM has historically been negative AAPL, much to their chagrin. Fool came into AAPL way after the real run.

    I'm not surprised to see a post here regurgitating a rumor. You guys know WSJ the originator of this rumor is owned by Rupert Murdoch of Faux News right?

    AAPL this bust has been a victim of massive manipulation.

    AAPL 11 p/e on 44.16EPS !!!! vs AMZN 3,645.15 p/e on 0.07 EPS!!!

  • Report this Comment On January 14, 2013, at 9:47 PM, rhealth wrote:

    I like turtles as well, but also squirrels.

  • Report this Comment On January 14, 2013, at 11:13 PM, Dennis129 wrote:

    So why not recognize that AAPL is mortal after all. It is an excellent, if grossly over-hyped franchise. Failure in the last I-Phone roll out (remember MAPS?) broke the spell and that old market standby -reversion to mean - stepped in. I think if AAPL really wants to create shareholder value, instead of dubious sare price point bragging rights, it would be best served with a 10 for I split, and a 25% net dividend increase. Moving back into the pack would allow a lot more oxygen in, even at the ego cost of the APPL glitterati

  • Report this Comment On January 15, 2013, at 4:48 AM, Thomas10Parker wrote:

    Bought AAPL@500.5 per signals from

    * J.P.Morgan

    ** I Know First system **

    Good Luck!

  • Report this Comment On January 15, 2013, at 8:36 AM, iggymod wrote:

    Apple has not cut at least one existing open order on a structural component of the iphone 5 body. The supplier I am referring to is actually a contingency plan to accomodate the need for excess capacity.

  • Report this Comment On January 15, 2013, at 12:58 PM, sept2749 wrote:

    AAPL is still a great company with room to run. I believe that the media plays a role in pricing AAPL - at least with individuals. Whenever there is a rumor or a hint of a problem the media goes to town with as much negativity as possible. What gets me is that people actually listen to this crap which is mostly BS content with wild headlines. The reason: advertising $$$$.

  • Report this Comment On January 15, 2013, at 6:02 PM, thomasbihn wrote:

    perpetuitas, You commented that Fool is negative and regurgitating the rumor. While they did post an article covering it, I'd hardly consider this a regurgitation of the rumor, but more of a debunking of it.

    As they mention, the figures cited in the WSJ are highly unlikely and the rumor is a remix of what has already been out in the open for weeks - an expected reduction in component orders aligning with a reduction in demand for Q1 for consumer items.

  • Report this Comment On January 16, 2013, at 9:15 PM, Tunatom wrote:

    Just visit Walt Whitman mall In Huntington ny and check out the Microsoft store with no customers,to the half hour wait at the apple store, and there is no question the I phone demand is there.

  • Report this Comment On January 16, 2013, at 9:18 PM, Tunatom wrote:

    Cnbc should start reporting on facts, not what ifs

  • Report this Comment On January 19, 2013, at 11:43 AM, prginww wrote:

    I've been consistently buying AAPL shares on every dip and will continue to do so, because, based upon my research, I stand to make a significant profit after the coming earnings release, followed by a substantial profit ($200 to $300) per share after the 2nd quarter release.

    Disclosure: Long AAPL and quite comfortable with it. This aging spaceman is now in his 70th orbit of our sun, and has been getting better at investing with accumulated experience... research and patience, tuning out the noise...take my advice or leave it, as you will, and good luck, Fools.

  • Report this Comment On January 19, 2013, at 12:09 PM, feenix1944 wrote:

    I'm Feenix1944, and I'm getting tired of posting comments only to have them listed as being written by "drym". If this happens again, I'll just simply not bother to write any more comments.

  • Report this Comment On January 20, 2013, at 12:25 PM, PinkFloydRoadie wrote:

    Regarding the "speculated" cut in orders for iPhone parts, I'll wait until I hear the reason from Apple. I don't think any conclusions can be drawn that is bad or good for Apple.

    A cut in orders can mean shifting or phase-in of other vendors, a seasonal order shift, lower demand, just a rumor, etc. Thus good or bad.

    One thing I don't think is correct is a "speculation" buy some media and Fools that the cut means an increase in yield during production processes and thus need for fewer parts. I (and fellow executives I know at other companies) have never modified orders based on changes in yield. We always place orders for "X" number of units and it was up to the vendors to manufacture overage to compensate for yield problems. Beside a point that after many generations of a product, the yield doesn't change enough to cause an order change even if that is the process that Apple uses.

    So in summary, you can guess all you want as to the reason for a purported cut in orders. Usually, it means not a good thing, but you can't make that assumption automatically.

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