J.P. Morgan: What the Apple buy side isn't buying

After initiating coverage for with a $272 price target, sell-side analyst Samik Chatterjee got an earful from investors.

From a note to clients that landed on my desktop Wednesday:

We thought it might be interesting to summarize the feedback we have received relative to our Overweight thesis on Apple since our initiation of coverage more than a week ago, including key areas of pushback, and aspects as to which investors desire more clarity.

  • Key pushback on Apple relates to pricing sustainability. Overall in our discussion with investors we have found the key area of pushback to be Apple’s ability to drive continued price increases as seen with the success of iPhoneX following the 2017 launch. Some investors we spoke to appear concerned relative to end-customer demand gravitating towards the yet to be released iPhone XR rather than the higher-priced iPhone XS and the iPhone XS Max, which appears to be driving consensus expectations to range from flat y/y to a modest uptick in blended ASP in 2019 compared to JPM expectation of +9% y/y. We believe consensus expectations for pricing are too conservative led by an underestimation of demand for the top-end phone which Apple has been successful in driving historically.
  • Installed base growth is a primary topic of discussion and current installed base growth appears not to be fully appreciated by investors. In our conversations with investors, we believe that Apple's recent comments for double-digit growth y/y in the installed base of devices, including 1.3 bn active devices in the installed base, is not fully appreciated by investors. Apple defines active device as one that has engaged with its services (e.g. iTunes sign, purchase, etc.) in the last ninety days. We expect growth in the installed base to moderate from a double-digit growth pace to high-single digit levels, led by the plateau in new iPhone units; although still marking a robust pace of growth...
  • Lack of iPhone shipment growth over last couple of year appears to be less of a concern; investors appreciate focus on profitability in a tough end-market. While concerns on pricing abound, the lack of meaningful increase in iPhone shipments over last couple of years does not appear to be as concerning to investors on a stand-alone basis, led in part by greater appreciation for Apple's strategic focus on profits relative to unit volumes in a tough end-market. However, there is a greater concern from investors on the implications of the plateau in iPhone unit volumes to the Services opportunity.
  • Investors appreciate the Services story, but are largely expecting continued progress rather than acceleration. While the firm’s strategic focus on Services opportunity is widely discussed by investors, our conversations indicate that most investors expect Services growth to track at a similar or modestly lower pace relative to the +18% Services revenue CAGR demonstrated over the last 5 years. However, we expect acceleration in Services growth, despite the moderation in installed base growth, led by: 1) Continued increase in time spent by consumers on mobile devices to drive higher engagement and revenues from the App Store; 2) Greater adoption of Apple Care services by third-party distributors; 3) Continued strong growth in Apple Music and Apple Pay, both of which will contribute an increasing portion of Services revenues over time.

Maintains Overweight rating and $272 price target.

See also: J.P. Morgan initiates Apple coverage at $272

My take: Buried in his bullet points is Chatterjee's estimate that Apple commands a ~50% share of the worldwide market for second-hand smartphones. That was news to me.

We believe the brand positioning and the longer life-cycle of iPhone hardware relative to hardware from mass market smartphone OEMs drive a strong ~50% market share of the secondary market for Apple, which we believe can continue to expand (particularly in the emerging markets) which we don’t currently model and can present upside to our estimates.


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