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Surprise! iPhone X May Be More — Not Less — Profitable Than iPhone 8

A couple months ago, Susquehanna estimated that Apple's (NASDAQ: AAPL) iPhone X would have a bill of materials (BOM) of $581, which suggested that the hardware margin on the 10th-anniversary handset would be significantly lower than prior iPhones (although modestly above Apple's corporate average). That was despite the iPhone X's starting price tag of $999. However, that BOM estimate was released just shortly after the device was unveiled, and well ahead of actual deliveries.

Now that iPhone X has launched, we're seeing the usual slew of actual physical teardowns that will yield more accurate estimates. The latest comes from teardown specialist TechInsights (previously Chipworks). Reuters reports that TechInsights pegs the iPhone X BOM estimate at $357.50. At a $999 retail price, that suggests a hardware margin of 64%. In contrast, the iPhone 8 hardware margin is estimated at 59%, according to the report.

Image source: Apple.

Aren't new products supposed to have higher cost structures?

Reuters points out that the estimates are "surprising because technology products tend to become more profitable as they age and the parts for them drop in cost." CFO Luca Maestri echoed this sentiment on the earnings call last week:

We also said that every time we launch new products, the cost structures of the new products tend to be higher than the products that they replace. It's inevitable. We are adding new technologies, new features. And therefore, the cost structures go up. We have a very good track record of taking those cost structures. And over the life cycle of the product, we are able to bring them down.


The explanation for this apparent discrepancy is that these BOM estimates generally don't include the depreciation of manufacturing infrastructure, and predominantly focus on component costs, while any manufacturing cost estimates usually just refer to labor costs. For comparison, you can also look at a detailed breakdown of IHS Markit's preliminary estimate for the iPhone 8 BOM from September.

This is also why I avoid referring to the implied profitability as "gross margin," as there are many other moving parts that go into cost of sales, including shipping costs, warranty accruals, software development costs, and most notably the aforementioned depreciation and amortization of manufacturing infrastructure.

When Apple launches new products, its investments in manufacturing infrastructure are substantial, and a significant contributor to the overall cost structure beyond components. The Mac maker ended up spending $14.9 billion in capital expenditures in fiscal 2017 (which was below its forecast), while depreciation and amortization on property, plant, and equipment was $8.2 billion. Product tooling and manufacturing process equipment is depreciating on a straight-line basis over one to five years.

The iPhone X may have a higher hardware margin than iPhone 8, but that doesn't mean it has a higher overall gross margin.

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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.