Expect margin pressures from Apple

The giant tech company is coming under pressure. No one thought it could happen, but consumers are fickle.

By Stock Traders Daily Dec 6, 2012 11:08AM

The Apple Inc. logo is displayed on the back of the new MacBook Pro David Paul Morris, Bloomberg via Getty Images

By Thomas H. Kee Jr., Stock Traders Daily

 

At the end of the first quarter of 2012, I warned that Apple (AAPL) could be reaching its pinnacle-point as a business. Since then, there have been several warning signs, including some top executives leaving the company.


But there is a more tangible problem that could affect the earnings growth that persisted throughout the recent years.


In the first quarter, I warned that Apple was not treating its customers right. It was gouging the service providers like Verizon (VZ), Sprint (S) and AT&T (T). And although that looks great to the bottom line and margins initially it also creates a divide that can become pronounced when retail items become less favored.

 

My key point was that consumers are fickle. Products move in and out of favor regularly and trends can turn unpopular overnight. If this happens when Apple is have problems with the service providers, serious problems could follow. That can lead to changes in analyst opinions and impact the stock price.

 

Specifically, in such situations margins could come under severe pressure that what would be normal because the service providers will promote products that afford them a better return and skew the percentage of sales even more than might otherwise occur. This is the way of business -- companies attempt to earn the most they can, which is part of the problem I foresaw after the first quarter of this year.

 

Furthermore, as the year continued, competition has become fierce as Motorola and Samsung specifically have caught up and in many cases surpassed Apple.


So I have recently begun to investigate using a "Random Walk" approach. I have been visiting retailers and asking a simple question: Are you selling as many iPhones as you did before? Resoundingly, the answer starts the same way: "we sell a ton of iPhones." However, as I dig a little deeper I also discover that the proportion of sales are changing meaningfully.


I have learned that the percentages are changing from what used to be 75% iPhone and 25% other phones to 60% iPhone and 40% other phones. Other phones obviously include the Motorola Droid Razr and other phones using Google's (GOOG) operating systems, and Blackberrys by Research in Motion (RIMM). But I did not go into detail about the percentages of the others.

 

Whether consumers are buying lower pricepoint was unclear. In fact, it sounded as if the level of spending was the same, but consumers were simply opting for other phones more often. This defines a loss in momentum for the iPhone, which is the foundation of Apple's earnings and revenue, and margins too of course. The competition has caught up with Apple. I warned about this in the first quarter, and we are seeing it unfold in front of our eyes now.

 

Beware of a company that has a divide with its retailers (service providers in Apple's case), especially when its products lose momentum. What might otherwise be a slight reduction in margins could become much worse if the retailers start to push other products more aggressively.

 

Although I pulled the short I had on AAPL off when the stock broke above $640, we transitioned to the two times short on the NASDAQ 100 (QID), which is largely influenced by AAPL, and that position is up about 10% since then. We continue to hold this position amongst others.

 

Of course, I am not saying that Apple will stop selling iPhones, IPads, or anything else or that sales will decline markedly. I also expect the loyal followers of Apple products to keep buying as much as they can. But the momentum has shifted. Apple-products are no longer cutting edge, and unless that changes, the margins pressures can cause earnings to slow considerably and the multiples to contract.

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