- Reset as Expected
? Reiterate Outperform. We maintain our Outperform rating, and adjust our
CY EPS estimates to $8.92/$10.20. After much market speculation, Apple
finally confirmed that the iPhone business may enter a period of decline with
its March quarter guidance. (We continue to see evidence of a subdued
iPhone 6s cycle. See our notes Apple: Lower iPhones, adjusting GM, the last
cut, Supply chain weakness continues, Supply chain continues to adjust).
We believe we now have a handle on the degree of GM erosion over this
subdued iPhone cycle. This, we believe, provides a baseline CY EPS
estimate of $8.92, meaning incremental downside risk is capped at ~$89.
With high retention rates, a superior ecosystem, and multi-product compute
advantage and an installed base of 1bn users, we believe Apple provides a
sustainable, annuity type FCF of ~$60bn per annum.
? iPhone declining in March, to slowly recover thereafter. We now project
iPhone units at 45.6mn in March (-25.4% yoy, -39.0% qoq). However, for
the calendar year, we forecast 202.0mn units (-12.8% yoy). While we see a
subdued iPhone cycle for the next few quarters, we believe units will recover
to 228.1mn in CY17 and remain constructive LT given installed base growth,
high retention rates and a normalization in replacement rates. Specifically,
we believe installed base growth, which we estimate at 23% since end of
2014, should drive upgrades and replacement with the iPhone 7.
? Focus shifting to GM's, declining overall, but well managed. We note
several items affecting GM over the next 12 months. The items we see
negatively impacting GM are: 1) The iPhone 6s cycle is lower GM than the
iPhone 6 cycle; 2) lower mix of 5.5 inch 6s Plus vs. 6s; 3) negative leverage;
and 4) currency. We note that this is being somewhat offset by a shift
towards higher memory, improving Watch margins and the iPad Pro. We
now project GM at 39.2%/38.7% and OM at 28.6%/28.2% for CY16/CY17.
? Valuation. We continue to believe that Apple looks inexpensive on a P/E excash
of 9x in the context of material capital return, sustainable revenues, and
a powerful ecosystem. We apply a ~12x multiple and see upside to $140.