When it comes to the smartphone sector, Berenberg Bank analyst Adnaan Ahmad has an equal opportunity approach. He advises selling basically everything.
In particular, this morning he issued Sell ratings on both Apple and Samsung. His basic position here is that the competition is going to get tougher from here. A lot tougher. And the result will be thinning margins.
?Since our initiation on the sector in January 2010, we have said that Apple and Samsung are the two ways to play the smartphone trend given their vertical integration and economies of scale coupled with component advantages,? he writes in a research note. ?We erroneously (it seems for now) stuck to this view on Apple and rightly (it also seems for now) stuck to it on Samsung ? Today, we downgrade Samsung and Apple to Sell. The smartphone investment of the past three years is now a smartphone trade. This is very similar to what happened in the handset industry a decade ago, when volumes topped out in developed markets and were led by growth in emerging markets. The only stock winners at that time were product cycle ?hope? stories ? Motorola for a few quarters with its RAZR model, Nokia for nine months with the N95, LG Electronics for two quarters with its ?Chocolate phone.? We are not good traders and thus prefer to stick with our focus on structural winners and losers in the global technology hardware arena which we think are mispriced. We keep our bearish structural views on HTC, Nokia, RIMM and ZTE.?
His view is that Apple and Samsung will continue to dominate the high end of the handset market, but he cautions that growth in that segment is likely to slow to the 10%-15% range, down from the 50%-100% range. Meanwhile, the low and middle segments of the market should grow at least 50% over the next 2-3 years, he says, as smartphone prices decline and emerging markets adopt these devices.
?We think the smartphone industry is at a similar juncture to the handset industry back in 2003, when penetration rates of handsets in developed markets were high and growth accelerated in emerging markets,? he writes. ?This led to robust industry volume growth, but ASP and margin structure came under pressure.?
Noting that smartphone vendors are likely to look to the supply chain as a place to cut costs, he also moves to Sell ratings on Hon Hai and Catcher Technology. He already had Sell ratings on Imagination, Qualcomm, Foxconn Technology, Foxconn International, Mediatek and TPK.
He also remains bearish on the infrastructure and networking segment. ?Yes, it has been the wrong call in the last three months and yes, 2013 may be a positive spending cycle primarily driven by the U.S. and Europe,? he writes. ?But the cycle in our opinion, will be over-powered at some point in the next 12 months by the structural headwinds that face these industries. Ericsson, ZTE, Huawei, NSN, Alcatel-Lucent, Samsung and now potentially vendors such as Cisco hitting the space from a small cell/WiFi angle coupled with telecom companies? continued schizophrenic behavior with regard to spending should in our view lead to further industry restructuring, exits and consolidation. Capacity needs to come out of the industry.?
His only Buy rated stock: ARM Holdings. ?Royalty rate inflation and end-market diversification remain the core tenets to our thesis here ,? he writes.
On Apple, his biggest concern is that margins are going to shrink over time.
?A 38% gross margin and ~28% EBIT margin are high in the context of consumer electronics,? Ahmad writes. ?If we assume that gross margins fall to the 30% level, where they were before the introduction of the iPhone, with 10% operating expenditure to revenues, this leads to $40 billion in annual operating profit. Taxed at 25% and capitalized at a 10% free cash flow yield gets you to $300 billion in value. Add its existing net cash of ~$140 billion and you arrive at the current market capitalization. The issues here [are] a) why do margin declines stop at 30% given where peer gross margins stand; and b) can you really value all of cash at par given that more than 65% sits off-shore??
He says the worst-case scenario for Apple is that it sinks to consumer electronics gross margins i.e. in the 20% range. ?So, on the same calculations as above, we get to $150 billionin value. Adding net cash of $140 billion means that the stock would fall ~30% from current levels to around $300 if, again, we value cash at par.?
The analyst asserts that Apple?s iPhone gross margins are likely to decline from 45-50% to about 35% in the next three years.
Concludes Ahmad: ?We know that we are late, but we think that the Apple share has further downside to the $360 level.?
AAPL today is down $3.67, or 0.9%, to $427.47.
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