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You’re Wrong About Apple Inc. (AAPL)’s Affordable iPhone

Apple Inc. (NASDAQ:AAPL)‘s margin contractions have rattled investors over the past year. By no means is Apple’s current level of profitability bad — rather, the Mac maker faces very hard comparisons with an extremely lucrative fiscal 2012. Apple is widely expected to launch an affordable iPhone model later this year, at long last pursuing a wider product portfolio.

Apple Inc. (NASDAQ:AAPL)

Many investors have thought that such a lower-priced model would further erode Apple Inc. (NASDAQ:AAPL)’s overall gross margin. Many investors may be wrong.

Word on the Street

Morgan Stanley (NYSE:MS) analyst Katy Huberty believes that the rumored affordable iPhone model will end up boosting Apple’s margins as opposed to the other way around. It’s true that the mid-range model will inevitably end up less profitable than the high-end flagship, but it’s also true that it may fetch a higher gross margin than the rest of Apple Inc. (NASDAQ:AAPL)’s products.

Add in the fact that an affordable model will boost unit sales significantly and that there’s some inherent operating leverage in Apple Inc. (NASDAQ:AAPL)’s business due to the scalability of software development, and the net result could very well be increased margins. Adding a $399 iPhone model to the lineup increases her total revenue estimate by 5% and gross profit by 6% in dollar terms, with a modest increase of 0.1% in gross margin. A lot of that upside would be driven by total iPhone units, with Huberty increasing her estimate from 77 million to 100 million for the second half of 2013.

This same effect is already starting to happen with the iPhone 4, the 2010 model that Apple Inc. (NASDAQ:AAPL) has been aggressively pricing in emerging markets. Apple has seen impressive spikes in iPhone units due to these affordability initiatives. For the current quarter, Huberty believes that Apple’s pricing efforts will translate into a 14% drop in iPhone 4 average selling prices — but also a 0.3% gain in gross margin.

Gross margin could be further reinforced by sequentially slowing sales of iPads and Macs, since those devices are less profitable than an affordable iPhone would be. Investors shouldn’t fret about a couple of basis points of profitability here and there. Instead, investors should acknowledge that the mid-range unsubsidized market (which is mostly abroad) is an enormous incremental opportunity for Apple Inc. (NASDAQ:AAPL) that it has yet to tap.

The article You’re Wrong About Apple’s Affordable iPhone originally appeared on is written by Evan Niu, CFA.

Fool contributor Evan Niu, CFA, owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple.

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