Analysts think Apple has gone rotten: Three banks downgrade to neutral

A disappointing reveal from tech giant Apple last night has seen analysts downgrade their buy recommendations in the company's stock to neutral.

No surprises last night despite promises from chief executive officer Tim Cook in May last year that security was being ramped up.

Crucially, Apple's budget iPhone 5C turned out to not be that budget. Analysts feel that the product is too expensive to have an impact in developing markets, where tariff plans are less common, and the handset is likely to reach customers at an unsubsidised $549 (£348).

UBS, downgrading from Buy to Neutral

Lowering to Neutral on lacking competiveness in key growth markets
We are downgrading Apple from Buy to Neutral on the concern that Apple's pricing strategy will hamper the company's ability to be competitive in key growth areas in the smartphone market, particularly in China. We were impressed by the specs of the 5S, surprised by the high price of the 5C ($549/649) at just $100 under the 5S without a contract, leaving little differentiation. Apple said that two phones replace the old 5, leaving the 4S as the low-end option – a three-year-old form factor.

Pricing strategy a head scratcher
We surmise that even if Apple secures a partnership deal with China Mobile in the near term, it will be challenged to compete against comparable Android (4-inch, quad-core) devices priced 40-50% lower than the iPhone 5C. A recent survey of 35,000 Chinese consumers conducted by ChinaDaily.com indicated that only 2.6% of respondents would consider purchasing the iPhone 5C at the $549 (Rmb4,488) level.

Estimate revision subtle, brand perception may slide
We are lowering our iPhone units from 175mn to 158mn on weaker demand from the low end. Despite the downward 10% unit revision, our revenue and EPS estimates remain intact, benefitting from a 10% higher iPhone ASP and a slightly higher gross margin. Our F14 EPS actually improves from $44.65 to $45.46. Despite the slight bump, we are concerned the opportunity as well as brand perception may be at risk of being diminished with a less accommodative pricing strategy in key growth markets.

Valuation: Upside to the stock unlikely for now
We are lowering our price target from $560 to $520, which leaves only modest upside from current levels. We expect shares to remain tepid in the near term until a China Mobile deal is finalized and Apple's competitive strategy gains clarity. Our $520 price target is pegged to an EV/FCF multiple of 6.8x our F14 FCF of $44bn and on a P/E of 11.5x our F14 EPS estimate of $45.46, a slightly increased discount to the group on lack of visibility and a less clear competitive strategy.

Credit Suisse, downgrading from Buy to Neutral

Downgrading to Neutral
As expected, Apple yesterday announced the iPhone 5s and iPhone 5c which both feature the newly redesigned iOS 7. In aggregate, we remain disappointed with Apple's decision to remain a premium priced smartphone vendor, and this continues to competitively expose the company and limits its TAM and growth. Given a lack of TAM expansion and lower iPhone sales potential, we lower EPS by 8% for FY14 and downgrade to Neutral.

Pricing strategy limits TAM
Apple's iPhone portfolio, for the next 12 months, by our estimates, will remain significantly in the >$400 smartphone segment, not incrementally different from recent years. This segment has seen peaked growth – with 300mn units sold per year and only modest expansion. In this low growth segment, Apple faces strong competition from Samsung, which holds the other 50% of category market share. Critically, by ignoring the mid-tier smartphone segment, Apple will continue to lose users to the Android ecosystem. On our new estimates, Apple's smartphone share will decline to 15.5%/13.1% this year and next from 18.1% last year.

Product launch lacking real innovation
The iPhone 5s has a new apps processor, improved camera functionality and new motion sensor functionality. However, these are game changers and are more evolutionary rather than revolutionary changes. The iPhone 5c is essentially a multicolored, plastic iPhone 5 and could cannibalize higher end sales and account for over 50% of unit mix over time bringing lower gross profit dollars. Most importantly, both products are premium devices, which have specifications not quite on par with that of other high-end smartphones.

Valuation – limited upside
We retain our price target of $525 - applying a 10x multiple and giving credit for the fully taxed net cash pile of $93bn.

Bank of America Merrill Lynch, downgrading from Buy to Neutral

D/G to Neutral; lack of catalysts, iPhone disappointment
We downgrade to Neutral on (1) lack of a “lower-end” iPhone and price points that will be too high to increase penetration in emerging markets (2) no China Mobile (CM) agreement, (3) a likely less than expected impact from China Mobile, when/if a partnership is announced – higher than expected pricing, no lower-end iPhone, (4) another “evolutionary but not revolutionary” iPhone product launch, and (5) risk to near term GM% estimates, given typical lower GM% on new iPhones (in this case both 5C and 5S, as opposed to only one new launch). On a positive note, the company did add NTT DOCOMO.

China Mobile incremental units could be less than expected
We estimate CM, when/if announced, to be only an incremental 6mn+ units annually (vs. our 170mn estimate), much lower than prior expectations, given lack of a lower end iPhone, very low iPhone penetration rates (5-10%) at China Unicom and Telecom, and iPhone pricing at $500+ compared to <$300 phones. In addition, CM’s 3G/4G network is underdeveloped, which should dissuade some purchases. NTT DOCOMO may provide more unit potential (9mn over 12+ months).

5S, 5C evolutionary not revolutionary
The biggest surprise/disappointment was the lack of a true “lower end” iPhone. The 5S keys include: 1) fingerprint scanner; 2) upgraded camera; and 3) faster processor (A7; 64-bit). The hardware features for the 5C are comparable to iPhone 5, aside from minor differences such as plastic casing, availability in more colors (green, white, blue, red/pink, yellow) and better front camera.

No change to estimates; PO remains $520
We maintain F2014/15 EPS estimates of $44.85/51.00 vs. Street $42.43/46.80. Our PO remains $520 on 11x C2014 EPS estimate of $47.10. Key positives for the Apple story remain, including valuation and capital allocation (buyback, dividend yield), although sentiment near-term should take a pause after a run up and positive EPS revisions may not occur, given aforementioned issues.