Why Brean's Baruah Remains Convicted In Apple's Ongoing Gross Margin Upside Story

• Apple Inc. AAPL shares are down 8 percent in the last one month, and have traded below the $120 mark since November 10.
• Brean Capital's Ananda Baruah maintained a Buy rating for the company, with a price target of $170.
• Apple could beat Dec Q EPS expectations on the back of strong gross margins, and may achieve meaningfully higher iPhone unit shipments than the current 2016 Street estimates, Baruah stated.

Analyst Ananda Baruah expects Apple to generate EPS of more than $3.35 in the December quarter, beating the implied guidance of $3.15 as well as the Street estimate of $3.25. He added that with iPhone gross margins approaching 47-48 percent, the company could achieve GM of more than 41 percent for the quarter, ahead of its guidance of 39-40 percent.

“Despite all of the supply chain 'noise' through the Dec Q, our view on builds hasn’t budged (70M – 75M) and neither has our view on ships (75M – 78M),” Baruah wrote.

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While the Street had unreasonably strong expectations of about 76M – 85M units shipped in the quarter, the analyst expects the company to meet this number, by building 70M – 75M and shipping the remaining units from inventory.

Mar Q iPhone builds have softened in the last 90 days, Barua said, adding that shipments are expected to have declined from 62M iPhone units 90 days ago to about 55M currently. The Street is readjusting expectations to 50M – 55M units, leaning towards shipments of less than 50M, which the analyst believes is “a gross exaggeration at this point.”

“We believe we can 'book' the 4-inch iPhone intro in the March-to-April time frame—and that it can provide 15M – 30M incremental units to CY16,” the Brean Capital report noted. Barua commented that Apple has the ability to ship around 250M iPhone units in CY16, representing 5-10 percent unit growth, while the Street is broadly expecting a 3-5 percent decline in iPhone unit shipments.

The analyst stated, “…the next true elongated stock 'move' will be determined by what CY16 iPhone ships can look like,” while adding that the Street numbers appear materially low through 2017. The EPS estimate for 2017 is $12.26, versus the current Street expectation of $10.70.