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Apple's New iPhone 12 Lineup Could Be Less Profitable

By Evan Niu, CFA – Oct 15, 2020 at 9:00AM

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Here are three reasons why the new smartphones might have lower gross margins.

Despite the fact that Apple (AAPL 0.19%) seems to be nickel-and-diming customers by omitting EarPods and a charging brick from now on, the new iPhone 12 lineup might still be less profitable than previous iPhones. While the company framed that decision as a boon for the environment, the cost-saving implications are just as apparent. However, higher component costs might offset those savings -- and then some.

Here's what Apple investors need to know.

Close-up of rear camera on blue iPhone 12 Pro

Image source: Apple.

Margins and ASPs could be under pressure

Barclays has issued a bearish research report about the new flagship smartphone, according to 9to5Mac. There are a few main factors that will drive up costs for Apple.

Most prominently, including a 5G modem -- likely Qualcomm's Snapdragon X55 -- that supports both mmWave and sub-6 GHz frequencies is pricey. Incorporating OLED displays across the entire lineup, as opposed to just the Pro models as in previous years, will also be an expensive proposition. Furthermore, Apple is doubling the base storage of the Pro models from 64 GB to 128 GB. Those three moves will put pressure on gross margin, particularly for the more affordable models.

At the same time, the standard iPhone 12 models are quite compelling, and Barclays expects the product mix to shift toward the iPhone 12 and 12 Mini, which start at $799 and $699, respectively. Since 128 GB may be sufficient for Pro buyers, they may opt for the base $999 iPhone 12 Pro instead of paying an extra $100 to boost storage to 256 GB. That could all result in lower average selling prices (ASPs), further hurting profitability.

The analysts also suggest that Apple failed to articulate why consumers should upgrade to 5G cellular technology. While Apple and Verizon highlighted impressive potential speeds of up to 4 Gbps during the virtual presentation, the reality is that most average consumers won't approach those levels since mmWave coverage, which is the fastest, remains sparse.

Barclays lowered its price target on Apple shares to $100, according to the report.

Apple cares more about gross profit dollars

It's common for new Apple products to start at the height of the cost curve, particularly when getting design overhauls that require new manufacturing infrastructure.

Apple spends heavily on new product tooling and manufacturing equipment at the onset of new design cycles, and then depreciates and amortizes those costs over many years. The company gets more life out of its designs than any of its peers (the outgoing flagship design has been in use for three years).

Perhaps more reassuring for investors, Apple might be able to significantly ramp overall unit volumes if it can spur an upgrade "supercycle." Apple cares more about growing gross profit dollars than it does about expanding gross margin percentage, and it can potentially still accomplish that goal if unit sales soar.

Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.

Stocks Mentioned

Apple Stock Quote
$148.31 (0.19%) $0.28
Verizon Communications Stock Quote
Verizon Communications
$38.33 (-1.67%) $0.65
Qualcomm Stock Quote
$126.81 (0.25%) $0.32

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