Citi analyst Jim Suva believes investors and the Street are seriously underestimating Apple's growth potential, especially related to iPhone 6 performance, saying he expects AAPL to beat consensus for March quarter sales by at least $1 billion.
Suva told investors in a note sent out Wednesday that his checks show rolling iPhone 6 and iPhone 6 Plus sales outpacing analyst consensus for the upcoming fiscal quarter. With iPhone being a huge contributor to Apple's overall revenue base, a Street misunderstanding of market trade winds could result in major beat.
Based on these factors, along with a few others, Suva put Apple shares on Citi's US Focus List, a designation granted only to the "highest conviction stock ideas." Explaining the decision, he outlines five key reasons why Apple should be trading higher: device acceleration; attractive valuation and currently low consensus estimates; increasing gross margins; Apple Pay and Passbook potential; and enterprise opportunities.
- Device Acceleration
Suva thinks device acceleration is a major underlying driver for Apple as cellular carriers are seemingly trending toward early iPhone upgrades in hopes of mitigating customer churn. For example, telcos run promotions that provide wireless subscribers opportunities to swap out their old devices for new units earlier on in a two-year contract.
- Valuation and consensus
Investors sometimes question if AAPL is too overpriced, but Suva argues the stock is currently trading at 14 times forward earnings or 11 times excluding cash of $25 per share. This is in comparison to the S&P 500, which trades at 17 times forward earnings. Importantly, industry consensus on Apple earnings potential is conservatively low, suggesting upward adjustments could be in the offing.
- Gross margins trending up
With a bevy of content-rich apps and generational camera hardware upgrades that eat up more onboard storage, Apple is primed to see a shift in consumer preference to devices with higher memory capacities. Apple prices iPhone storage tiers (16GB, 64GB and 128GB) in $100 increments, but only pays about $20 for the extra modules, suggesting an 80 percent incremental gross margin. Further, Apple guidance for its second fiscal quarter of 2015 stands at 38.5 to 39.5 percent, compared to 37.5 to 38.5 percent in the trailing quarter.
- Apple Pay and Passbook
Apple Pay is currently limited to the U.S. market, but as it rolls out internationally, Suva expects Apple to make great strides in mobile payments. He notes Apple Pay is only part of Passbook, which itself could be a potential driver of future growth.
- Enterprise
After capturing the consumer market with high quality products, Apple has a chance to parlay that success into enterprise. Citing Apple's recent partnership with IBM, Suva sees Apple investing in business-minded products and services, possibly leading to a holistic enterprise mobile solution.
Suva offers one more "bonus" reason, noting Apple Watch is about to launch in late April. He predicts the first-generation device to sell about 7 million units over 2015, but estimates that number to increase to 20 million next year.
Citi reiterates a buy rating at a target price of $145 and is modeling second quarter revenue at $56.6 billion, a 24-percent increase year-over-year.
Apple is scheduled to report fiscal quarter two earnings on April 27.