Increasingly, it seems Apple's (NASDAQ:AAPL) rumored smartwatch is vaporware. The newest revelation, courtesy of KGI Securities, estimates the company will not bring the device to market before 2015. Specifically, KGI's lead Apple analyst Ming-Chi Kuo stated:
We reiterate our view that iWatch, as compared to existing products, and as Apple's (US) first attempt at a wearable device, represents a much higher level of difficulty for the company as regards component and system design, manufacturing and integration between hardware and software. While we are positive on iWatch and believe that the advantages of the design and business model behind it are difficult to copy, we think, given the aforementioned challenges, that the launch could be postponed to 2015.
There's a lot to dig into here, but what will happen to investors if Apple doesn't bring a smartwatch to market until 2015?
Top-line growth concerns
Clearly, Apple investors know the issue Apple has had over the last year: slowing top-line growth. As a matter of fact, during the last four quarters Apple's top line has only increased 5.1% on a year-over-year basis. On a product-line basis, Apple's iPhone lines and iTunes/Services/Software are heavily contributing to revenue growth by growing at 10.6% and 15.9%, respectively.
On the negative end of things, the iPad and the iPod presented headwinds to the company's overall top-line growth by falling 5.4% and 47.4%, respectively. And while the iPod is a minute part of Apple's overall revenue haul, the iPad drop is important and noteworthy. Coming in at $31.2 billion, Apple's iPad line is its second-largest product, and contributes roughly 18% to Apple's top line.
But investors pay for earnings, right?
A common knock against worrying about Apple's top-line growth deceleration is to look at earnings growth. And that makes sense, because ultimately investors pay for earnings. When viewed from that angle, it appears Apple is performing better.
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Apple's been able to produce earnings-per-share growth of 8.2% on the back of a 5.1% revenue increase. Some of that is attributable to Apple's massive share buyback, but some of it has been a return of Apple's gross margins that hit two-year lows around the third quarter of 2013.
The smartwatch can solve both problems
Apple's problem is twofold: how to grow revenue and keep its high gross-margin percentage in check. According to analysts, the rumored smartwatch accomplishes both of these things. Apple analyst Katy Huberty of Morgan Stanley has modeled for 30 million to 60 million of sales during the product's first 12 months of existence at an average selling price of $300, and gross margins between 40%-50%.
While these appear to be ambitious estimates, they illustrate the potential of this product. On an incremental basis at the mid-range, that adds nearly $13.5 billion in revenue -- good for an increase of 7.6% on its own. Furthermore, using the 45% mid-range provides another $6 billion in gross profit.
In addition, astute readers should notice that Apple's smartwatch gross margins appear to be higher than the company's overall margins. For a point of comparison, if we apply Katy Huberty's estimates to the last four quarters, this pulls Apple's average gross margin percentage during that period from 38.4% to 38.8% -- a 40 basis point improvement.
Yeah, but is this "priced in?"
A common question from investors and analysts is whether or not an event is "priced into" the stock. Essentially the question is if investors, as a group, already adjusted to the news, and adjusted the stock price accordingly? It doesn't appear so. Look at market capitalization during the last two years -- the last time Apple had a market cap in excess of $600 billion -- and you see that on a price-to-earnings ratio basis, it's trading near its highs.
While investors do pay for earnings, they are looking at future earnings more than current numbers. The company's stock has been red hot during the last year, up more than 40% on the back of a favorable news cycle that included a dividend increase, a 7-1 stock split that drove the price up foolishly (note the small f), and increasing euphoria about the newest iPhone iteration.
However, at some point the iPhone 6 will become old news; all iPhone iterations do. At that point, investors will have to ask, what's Apple's next catalyst to grow both revenue and net income? My fear is that, without a new product, it will be hard for Apple to answer that question.
Apple's a truly revolutionary company that has redefined so many products, it's almost impossible to keep track of all of them. However, we need Apple to dig into its bag of tricks to amaze us once more. And while I understand that Apple doesn't bring products to market before they are fully vetted, fans and investors are anxious to see something new. Tim Cook, we're all counting on you.
Jamal Carnette has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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