Could a Cheap iPhone Cheapen Apple?

In a note Wall St. Cheat Sheet received from Piper Jaffray analyst Gene Munster, Apple (NASDAQ:AAPL) may not perform as well as previously expected, but it could still be valuable.

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A large portion of Munster’s note was on the effects that a cheaper iPhone would have on Apple. His expectation is that the company will release a low-end iPhone in September with an average selling price of about $300. But releasing the device could have some undesirable effects for the world’s largest tech company.

A low-cost iPhone would certainly help Apple compete with the slew of cheap Android smartphones that are available on the market. However, an alternative to the more expensive iPhones could cannibalize high-end iPhone sales, as users who just want an iPhone without concern about having the latest and greatest may opt for the cheaper iPhone, cutting sales of the higher-end, higher-margin devices.

Munster predicts that a cheap iPhone could command a margin of 30 percent at an average selling point of $300. The margin for the higher-end iPhones has been around 55 percent with an average selling price of $620. Munster also believes that the low-end iPhone would have a 30 percent cannibalization rate, bringing Apple’s gross margin down to 36.6 percent for calendar year 2014, compared to 38.6 percent in December of 2012…

The cheaper iPhone could have some benefits for Apple as well, as it would quickly allow the company to tap into a section of the market that it’s previously been unable to reach. At $300, the device would be able to compete with a lot of other cheap smartphones, but it would also carry the brand and production recognition of Apple’s other iPhones. Munster predicts that the device could quickly capture 11 percent of the low-end smartphone market in calendar year 2014.

As far as the company’s stock, Munster believes that Apple will increase the annual dividend from $10.60 to around $14 after it posts its March results. Apple will likely do this using its U.S.-generated cash and may also begin take on debt to pay the dividends. Increasing share buybacks may also be on the table, but Munster says that may not be announced with the March results.

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His expectations for Apple are below the Street. He believes Apple will post June guidance that is lower than Street estimates. Piper Jaffray’s estimate for June revenue is $35.1 billion, and the firm believes Apple will guide between $34 billion and $36 billion. Gross margins for June could also be up sequentially from March, as economies of scale are expected to improve the margins.

Piper Jaffray maintained that Apple stock was overweight and reduced its price target to $688, down from $767.

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