Analysts: Watch Out for Falling iPhone Sales

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Analysts at Societe Generale downgraded shares of Apple (NASDAQ:APPL) to hold from buy on Tuesday. Their fear is slowing sales of the iPhone 5S — the latest iteration of the company’s flagship smartphone that introduced the biometric authentication application, Apple ID Touch, a next-generation CPU, the M7 motion-tracking chip, and an improved camera. Technology reviewers at CNET called the device “the fastest and most advanced Apple smartphone to date,” but noted that it was not a “required upgrade.” That commentary suggests, as does Tuesday’s downgrade, that the iPhone 5S may not be the obvious choice for the first-time smartphone buyer as early editions of the device were. Apple is no longer the clear frontrunner; its rivals have caught up.

“Usually, we would expect Apple to outperform the market in [the fourth-quarter] as the company has just issued new products,” wrote the analysts in a research note acquired by MarketWatch. “However, our research suggests that volumes may come in below expectations.” Société Générale’s Andy Perkins explained that the firm has calculated Apple sold 52 million smartphones in the final quarter of 2013, with the iPhone 5S selling much better than the its cheaper counterpart. In fact, he postulated the company has sold 4 iPhone 5S units for every iPhone 5C. But even though the lower-cost iPhone 5C, which features a colored polycarbonate shell, is selling fewer units, the device is still expected to negatively impact results. “With the lower-priced 5C model in the mix, our assumed average selling price for [the first-quarter of 2014 is 4 percent] lower than the previous year,” Perkins added.

Perkins and his team of analysts decided to stick to a price target of $575 for shares of Apple. The stock opened on January 21 at a price of $540.99, making their target price an increase of a little more than 6 percent. Already, in the past three months since the debut of the company’s latest devices, Apple investors have bid shares up approximately 7 percent. However, if demand falls faster than expected or if competition significantly intensifies — thereby impacting the iPhone maker’s pricing and margins — the stock may not reach that target.

Apple released the iPhone 5S and the cheaper iPhone 5C, in September, two devices that were not the technological leap forward that analysts had desired. Philip Schiller, Apple’s senior vice president of Worldwide Marketing, described the iPhone 5 — which is quite similar in design to the company’s latest devices — as “the most beautiful consumer device that we’ve ever created.” That may well be the case, but the smartphone market is much different than when the iPhone was first released. When the iPhone 4 was released in June 2010, it was clearly the phone to own. At that time, Google’s (NASDAQ:GOOG) Android phenomenon had not yet begun, Samsung (SSNLF.PK) had not developed the Galaxy phone, and Nokia (NYSE:NOK) and Research in Motion — now BlackBerry (NASDAQ:BBRY) — were at the beginning of their decline.

Now, Apple is having a difficult time proving the superiority of its newest phone against the success Samsung, whose handsets account for one of every three phones sold worldwide. Critics have noticed that the iPhone is no longer far ahead of Samsung or Google-owned Motorola as it once was. When the iPhone 5S and 5C were released, Wall Street and technology experts gave a collective shrug. The problem is Apple was expected to outmatch all the product releases it has made in the past and disprove the industry perception that Samsung has narrowed the innovation gap with its largest competitor. But progress in the smartphone market is now harder to come by.

For years, each subsequent generation of iPhone was an exercise in creative destruction that rendered the devices manufactured by its competitors, Nokia and BlackBerry, nearly obsolete. However, the technologies debuted on the iPhone 5S — the slightly faster A7 processor, the improved camera, and the fingerprint scanner — suggest technological leaps forward are shrinking in size. “I don’t think there was anything fundamentally disappointing out of Apple despite the fact that there was lot of anticipation,” IDC’s Will Stofega explained in the days following the September release “What we’ve seen with Apple and other vendors is they’re incrementally changing and improving things.

Still, the battle for smartphone market supremacy is far from concluded. While data from research firm Gartner shows that Samsung sold almost three times as many smartphones as Apple in the third-quarter, Apple did gain market share in the United States last quarter. A study conducted by the NPD Group found that 42 percent of smartphone owners in the United States owned iPhones in the fourth-quarter of 2013, a 35 percent increase from the year-ago quarter. Samsung saw market share increase as well, with the number of U.S. smartphone owners using handsets manufactured by the South Korean technology company increasing from 22 percent in 2012 to 26 percent. Those gains came at the expense of Motorola Mobility, HTC, and BlackBerry.

The survey did not track phones using Microsoft’s (NASDAQ:MSFT) Windows Phone operating system, so Nokia — whose phones use that software — did not appear in the results. While Apple has had to face exceedingly high expectations from investors and smartphone owners alike, Samsung has had its own problems.

The last quarter was a difficult one for Samsung. The company may be the largest smartphone handset manufacturer in the world, but the company’s earnings fell in the last quarter of 2013, further supporting investors’ concerns that the competitive pressures in the smartphone industry would make huge profits hard to come by in coming quarters. Strong smartphone sales pushed Samsung’ earnings to record highs over the past two years, but weighty marketing costs and increased competition from low-cost Chinese rivals have slowed profit growth.

Apple did suffer a great deal of negativity earlier this year, as investors questioned whether the company had lost its innovative touch. However, now the tenor of the technological discussion is changing. Both smartphone manufacturers may be facing a high-end smartphone market that is becoming saturated, yet Apple is on the offensive while Samsung is on the defensive.

But as Apple investors well-remember, this is not the company’s first downgrade of the year. The iPhone maker opened 2014 with a ratings drop from Wells Fargo Apple analyst Maynard Um, who changed their outperform rating to market perform based on concerns for Apple’s gross margins. While Um thinks that iPhone and iPad sales and gross margin should remain strong in the near future, he is worried that those strong sales and margin numbers are already priced into the stock. The iPhone maker will report fourth quarter results on January 27.

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