Apple (AAPL 0.52%) has gone from Wall Street darling that couldn't miss to a contrarian play trading at earnings multiples well below the broader market.
With iPhones still flying off the shelves and the Mini an early hit, many investors are left wondering whether there are deeper problems with Apple that they're missing, or whether the current sell-off makes Apple a screaming buy.
We've created a brand-new report titled "Is Apple's Epic Run Over?" that gives investors a comprehensive look at Apple. It answers whether the bears are right, or whether Apple has huge advantages investors are overlooking. Following is a sample section of the report that focuses on Apple and its hidden cost advantages compared with its competitors. We hope you enjoy this preview content from our premium Apple report.
Apple's critical cost advantage, added up
Adding up Apple's cost advantages in both SG&A and R&D, we arrive at a 10-16 percentage point advantage in cost savings relative to sales. Apple's relative advantages in these two areas led to added profits of anywhere between $12 billion and $19 billion last year.
To review tablets we've looked at earlier in the report, here is Apple's 3-6 percentage point advantage in low R&D costs relative to competitors.
Company |
Percent of Sales |
Absolute Total Spend (Millions) |
---|---|---|
Apple |
2.2% |
$3,381 |
Samsung |
5.9% |
$10,169 |
HTC |
4.3% |
$488 |
Nokia (NOK -0.27%) |
15.8% |
$6,507 |
Research In Motion |
9.6% |
$1,447 |
Dell |
1.7% |
$1,001 |
Lenovo |
1.7% |
$545 |
Microsoft |
13.8% |
$9,942 |
|
13.1% |
$6,208 |
And here is the company's SG&A relative to peers. As you can see, Apple has anywhere from a 6-10 percentage point advantage over its general peer group.
Company |
Percent of Sales |
---|---|
Apple |
6.4% |
Samsung |
16.7% |
HTC |
12.5% |
Nokia |
13.9% |
Research In Motion |
14.6% |
Dell |
14% |
Lenovo |
7.9% |
Microsoft |
25.5% |
|
18.9% |
These cost advantages go a long way in helping to explain why competitors were initially unable to undercut the iPad's pricing even as Apple reaped in huge profits on the device. Much ink is spilled about how Apple can charge a premium for its products. However, the real storyline is that the "premium" Apple is charging has been decreasing in areas like tablets. In its place, Apple's margins are bolstered by its outstanding control of expenses relative to peers.
The iPad's gross margin (the difference between revenue and cost) is generally considered to be in the 30% range in any given quarter. Let's use this to illustrate how Apple's cost advantages allow the tablet to be such a formidable threat to competitors.
Below I've assumed that Apple and a group of competitors are all selling tablets for $500, and I've generously assumed that their cost of goods sold -- or COGS -- is equal to that of Apple. (We'll have more on Apple's COGS advantages below.) Using the figures from above for each company's SG&A and R&D spend as a percent of sales, here's their profit potential:
Company |
Tablet Price |
COGS |
SG&A |
R&D |
Op. Profit |
Taxes (Assumed at 25%) |
Profit |
Profit Margin |
---|---|---|---|---|---|---|---|---|
Apple |
$500 |
$350 |
$32 |
$11 |
$107 |
$26.75 |
$80.25 |
16.1% |
HTC |
$500 |
$350 |
$62.50 |
$21.50 |
$66 |
$16.50 |
$49.50 |
9.9% |
Samsung |
$500 |
$350 |
$83.50 |
$29.50 |
$37 |
$9.25 |
$27.75 |
5.6% |
Nokia |
$500 |
$350 |
$69.50 |
$79 |
$1.50 |
$0.38 |
$1.13 |
0.2% |
Is this a perfect example that encompasses all nuances of tablet costs? Of course not; the incremental SG&A and R&D spend on creating a tablet might differ from wider company totals. Also, retailer mark-up may differ by product and company. However, this is an excellent broad example of Apple's cost advantages in action, which led to competitors being unable to undercut the iPad's pricing until the introduction of the Kindle Fire and the Nexus 7 -- two products not making any money directly, that will be discussed in more detail later.
The obvious question: Can Apple maintain this kind of structural cost advantage over the long run? As we see in the table below, aside from its 2009 fiscal year when economic turmoil stunted growth, Apple has managed to grow sales far in advance of expenses like cost of goods sold and research and development. That is, its scale has only increased its advantage in these areas.
Line Item |
2008 |
2009 |
2010 |
2011 |
2012 |
---|---|---|---|---|---|
Sales |
53% |
14% |
52% |
66% |
45% |
SG&A |
27% |
10% |
33% |
38% |
32% |
R&D |
42% |
20% |
34% |
36% |
39% |
At the end of the day, these savings are an inherent bonus of being Apple. If the company stops receiving gratis product placement that saves on advertising costs, there are bigger problems regarding Apple losing its brand cachet and design lead over competitors.
If R&D spins out of control, the company is likely losing focus and has lost a strong central decision-making team that's making the right bets on what consumers want next. If Apple ever has a $15 billion research budget, it's time to sell the company for reasons bigger than a margin hit from increased R&D spending.
Bottom line
Apple investors should feel secure in these cost advantages continuing in the coming years and staying well below industry averages. That leads to a key and underfollowed competitive advantage, especially as Apple continues building out a tablet market which has no shortage of growth potential in coming years.