Why the iPhone Can Drive Apple Higher, Even If the Watch Stinks

By Chris Lange Updated Apr 28, 10:25AM EDT · Published Jul 9, 3:42PM EDT

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Apple Inc. (NASDAQ: AAPL) is coming up on its fiscal third-quarter earnings announcement, and analysts think that it is ramping up for something larger later this year. This company is considered by many to have one of the best products and ecosystems surrounding its iPhone, and as a result it has been able to move massive quantities of iPhones. Could Apple move even more? Merrill Lynch believes that it has the answer to that question.

In its report, the firm totally ignored or at the very least failed to mention the Apple Watch. MarketWatch reported that sales of the Apple Watch dropped 90% since the opening week, which could in fact play a role in Merrill Lynch’s report.

Recent press reports suggest that the supply chain is gearing up to build as many as 90 million units. This compares to Merrill Lynch’s estimate of 74 million iPhones shipped in the September and December quarters combined in 2014. Currently, Merrill Lynch is modeling a roughly flat second half of 2015, compared to the second half of 2014. The firm’s estimate for total iPhone production (including older models) is roughly 115 million units, which could end up being on the conservative side.

The iPhone 6/6+ launched in September 2014, but the phones were not available in China until a full month later. In Merrill Lynch’s opinion, Apple could pursue a simultaneous release of the iPhone in China this year, which could explain at least half the roughly 15 million-unit higher build rate this year. Incrementally, Apple is likely continuing to gain market share versus Android and converting more users into the iOS platform, which could also justify higher builds.

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According to Merrill Lynch:

China has become a strategic market for Apple and the company’s Greater China (China, Hong Kong and Taiwan) revenues accounted for 29% of total revenues in fiscal second quarter. There are worries that given the sharp declines in the Chinese stock market that consumer spending could weaken. Although we acknowledge this risk, we note that iPhone sales have been fairly price inelastic, evidenced by consumer preferences to overwhelmingly adopt the new iPhones every generation although prices of the older versions move down. Further, if China accounts for 20% of iPhone shipments, a 20% decline in demand would result in roughly 9mn lower iPhones for the year (4% of total iPhones shipped), which could be made up by the increased distribution (21 stores in 11 cities as of April to 40 stores by mid-2016).

As a result of this, Merrill Lynch reiterated a Buy rating with a $145 price objective, implying an upside of 20.8% from current prices. The rationale behind this was the strong iPhone product cycle, the development of new revenue sources like Apple Pay or Apple Watch, and the optionality provided by a significant cash balance that can help accelerate innovations into new markets. Note that this price objective is lower than the consensus price target.

Shares of Apple were down 2.1% at $120.02 late on Thursday. The stock has a consensus analyst price target of $148.88 and a 52-week trading range of $92.57 to $134.54.

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About the Author Chris Lange →

Chris Lange is a writer for 24/7 Wall St., based in Houston. He has covered financial markets over the past decade with an emphasis on healthcare, tech, and IPOs. During this time, he has published thousands of articles with insightful analysis across these complex fields. Currently, Lange's focus is on military and geopolitical topics.

Lange's work has been quoted or mentioned in Forbes, The New York Times, Business Insider, USA Today, MSN, Yahoo, The Verge, Vice, The Intelligencer, Quartz, Nasdaq, The Motley Fool, Fox Business, International Business Times, The Street, Seeking Alpha, Barron’s, Benzinga, and many other major publications.

A graduate of Southwestern University in Georgetown, Texas, Lange majored in business with a particular focus on investments. He has previous experience in the banking industry and startups.