Apple (NASDAQ:AAPL): Gross Margin Deep Dive 2.0: GM Headwinds Not Secular; Raising CQ4 GM Estimate; Buy - Jefferies

Peter Misek a well plugged in analyst from Jefferies & Co is out with markedly positive comments on Apple (NASDAQ:AAPL) this morning reiterating his Buy rating and $900 price target.

- Apple's gross margin issues will be resolved by Q4, Misek says.

Jefferies sees three sources of CQ4 GM upside: 1) Their analysis of every Apple SKU and component yield issue indicates 168bp of improvement during CQ4; 2) Jeffco's CQ4 53M iPhone est is 5-7M above St, which could boost GM by 80bp; 3) GM guidance historically ~300bp below actual. Their analysis points to another 200bp GM improvement in CQ1. Firm raises their CQ4 GM est from 39.0% to 40.0% (guidance 36%, St 38.6%) and EPS from $15.50 to $16.00 (St $13.52).

GM Deep Dive 2.0 and an analysis of component yield issues indicate 168bp of improvement during CQ4. Jefferies analyzed all the Apple product SKUs' ASP, BOM, and GM. They also analyzed the nine components that their checks indicate are seeing yield issues when trying to meet the high level of demand. Firm's conclusion is that these yield issues are a ~376bp headwind at the beginning of CQ4 but should improve by ~168bp this quarter.

Notably, they think the key bottleneck for the iPhone is currently assembly at Hon Hai. In CQ3 they believe Hon Hai had ~50K idled employees due to component bottlenecks limiting the iPhone 5 ramp. After display and 28nm bottlenecks were alleviated, they believe the situation has flipped and that Hon Hai is trying to hire more people to meet demand. Jeffco believes Apple is paying Hon Hai higher amounts to make up for the idled reserved CQ3 capacity as well as to foster increased CQ4 hiring. Recently Hon Hai’s chairman noted to reporters, “It's not easy to make the iPhones. We are falling short of meeting the huge demand.”

Also, the firm sees Qualcomm’s CQ4 MSM shipment guidance of 168-178M (St 172M) vs. CQ3’s 141M as implying ~60M CQ4 iPhones and supportive of Jeffco's 53M estimate. Qualcomm’s major customers are HTC and Samsung. HTC guided CQ4 revenues -14% Q//Q and Samsung guided its high-end handsets flattish Q/Q. Assuming Qualcomm’s non-Apple business grows slightly Q/Q would imply a 33M increase in iPhone shipments or ~60M total for CQ4.

Jefferies' CQ4 53M iPhone est is 5-7M above St, which could boost GM by 80bp. They continue to believe that the display bottleneck has been worked through, that the current bottleneck is now assembly, and that Apple recently raised its CQ4 iPhone build plan from 55-60M to 60-65M (JEF shipment est 53M). Firm believes St is too low at 46-48M. Firm believes iPhones will have a blended GM of ~48% in FQ1, below the low 50%s GM in prior Qs.

GM guidance historically ~300bp below actual. The last two years Apple has beaten its GM guidance by an average of 291bp and the last two CQ4s Apple has beaten it by 360bp.

Raise  CQ4 GM estimate from 39.0% to 40.0%. Firm notes they originally modeled 300bp above Apple's 36% guidance to account for Apple's typical conservatism; however, their analysis leads us to believe that Apple included no yield improvement for units or COGS in its guidance. They see iPhone upside and continual BOM yield improvements throughout the quarter adding 100bp to their prior GM estimate.

Analysis points to another 200bp GM improvement in CQ1. Jefferies thinks the yield issues will be largely worked through so that the 376bp headwind will have mostly dissipated. This implies a 200bp Q/Q GM uplift to 42.0% (St 41.0%). Additionally, they believe Apple is able to pressure its component suppliers and get price concessions of ~2-5% per Q.

Reiterates Buy and $900 target.

Notablecalls: Margin issues are mostly to blame for the stock's 150pt slide. Now we have a well respected analyst out saying the issues will likely be resolved faster than the Street thinks. That makes the stock a buy. Simple as that.

I would not be surprised to see the stock above $570/share level as soon as today.