Apple: JPMorgan Sees Gross Margin Upside

Tickers in this article: AAPL

NEW YORK ( TheStreet) -- JPMorgan analysts, who on Thursday reiterated their "overweight" rating on Apple with a price target of $725, expressed optimism about upside potential to the tech giant's gross margin in the March quarter ahead of its earnings announcement next Tuesday.

Mark Moskowitz and Mike Kim also wrote in their report that Apple could be on the brink of driving a major leveraging up for a bigger stock buyback and dividend program that could build a "New Apple" focused on profitable innovations and greater shareholder returns.

"We continue to think that Apple is still trading like a value stock despite its above peer growth potential," they noted.

In its first-quarter earnings report, Apple had forecast gross margins of 37.5% to 38.5% for the fiscal second quarter vs. the peak 47.4% in the same quarter a year ago, prompting investors, particularly growth-based investors, to reduce their exposure to the stock in recent months for fear the company's consolidated gross margin could collapse to the 30% to 35% threshold.


But Moskowitz and Kim wrote a Thursday client note saying these fears are overdone. The supply chain inefficiencies that led to a hit in gross margins have mostly been resolved, they wrote, increasing the potential for higher gross margins in the March quarter and beyond. In their view, Apple returning to 40% or better gross margin could revive interest from growth-based investors who are averse to owning any stocks having downside risk to gross margin.

They further noted that Apple's foray into the midrange segment with a lower-priced iPhone does not mean the company's gross margin profile will collapse. A lower-priced iPhone, which would likely sell for about $350 without an annual service contract, could contain lower quality display and casing components to construct a bill-of-materials close to $175, they estimated. They also said that Apple could reduce costs by using its own applications processor and targeting savings in NAND flash and DRAM memory.


Adding in royalties, freight and logistics costs, and the total cost of sale could equal about $200, implying a 43% gross margin, Moskowitz and Kim calculated. That's lighter than the 45% to 55% profile for the iPhone 4 and iPhone 5, but exceeds Apple's consolidated gross margin figure.

The analysts predict Apple could perform better than investors expect for the fiscal second quarter as iPhone sales reach within earshot of JPMorgan's forecast for 40 million units, "signaling the product has not lost its way." They expect that Apple's June quarter outlook may be conservative ahead of potential iPhone and iPad updates, but that this could be overlooked by investors if the March quarter results were better than expected.