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1 Hidden Reason Why Apple's Margins Are Falling

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Much ado has been made over Apple's (NASDAQ: AAPL  ) gross margin contractions over the past year. Gross profitability peaked at an absurd (and unsustainable) 47.4% a year ago, and has fallen dramatically since. At the time, the company attributed this incredible figure to historically low commodity pricing, since gross margin came in a whole 5.4% higher than Apple's guidance.

That level of profitability may have spoiled investors, as Apple now faces tough year-over-year comparisons. Nothing looks as good as 47% margins for a company with meaningful hardware operations.

Source: SEC filings and conference calls. Calendar quarters shown.

There are a number of reasons why Apple's gross margins have been falling, including pricing pressure and product mix shifts toward less-profitable devices. The iPad Mini is also hurting profitability, since it carries a gross margin well below Apple's corporate average.

However, there's another possible reason that's somewhat hidden: depreciation.

Appreciating depreciation
Apple has dramatically ramped up capital expenditures in recent years, with most of this spending going toward product tooling and manufacturing equipment. These increases in property, plant, and equipment are also accompanied by higher depreciation expenses as a result.

A portion of depreciation expense is included in cost of sales, which affects gross margin. Depreciation expense has skyrocketed recently. For example, total depreciation and amortization expense last quarter was $1.7 billion. That single quarter's depreciation and amortization expense was more than half of the $3.3 billion in expense throughout all of fiscal 2012.

Apple's accumulated depreciation and amortization has risen over 40% over the past six months, to $9.2 billion, with the vast majority of its property, plant, and equipment comprised of machinery and equipment.

UBS analyst Steve Milunovich estimates that 1.6% of the total 9.6% year-over-year gross margin decline was attributable solely to increased depreciation expense.

The benefit of this spending is unrivaled manufacturing processes and higher quality products, which in turn contribute to Apple's premium branding and help it maintain some relative pricing power (even if there are industrywide pricing pressures).

There is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.

Read/Post Comments (4) | Recommend This Article (2)

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 April 25, 2013, at 2:23 PM, alan0101 wrote:

    Gross margins tell us not much of Apple performance and prospects because of growth rates, new product introductions and mix. Only analysts and bankers are fixated on them, to look at them quarterly is plain dumb

  • Report this Comment On April 25, 2013, at 2:45 PM, PaulApp wrote:

    Apple is killing itself! Reduced price iPhones and cheaper phones and smaller iPad contributed to lower margins!

  • Report this Comment On April 25, 2013, at 3:07 PM, artlaz wrote:

    A lot of the new tooling and machinery probably hasn't produced a product for sale yet. Everyone knows Apple is working on new screen technology, smaller faster lower power chips, fingerprint technology, better battery technology, etc. Hopefully all this CapEx is going to turn into some amazing new products later this year.

  • Report this Comment On April 25, 2013, at 4:13 PM, ConstableOdo wrote:

    Android is seriously undermining Apple like rats gnawing at a human's ankles. Every day a new Android smartphone comes out with the latest and greatest components. Apple can barely put out one smartphone a year. Within a couple of months the iPhone is considered obsolete and everyone yells that Apple is falling behind. I think that would happen in any industry where a new product is introduced every week. Tech pundits and Wall Street are spec freaks. Any device with better specs is always assumed the better product with tech pundits. So Apple will always be behind 51 weeks out of the year.

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