Will Supply Constraints Temper the iPhone’s Impact for Apple?

Apple’s (NASDAQ:AAPL) iPhone is receiving extraordinary acceptance in Asia according to industry analysts. ^[1] Sanford Bernstein analyst, Toni Sacconaghi, estimates that three of the main carriers in Asia including China’s China Telecom, Japan’s KDDI, and South Korea’s LG Telecom could help Apple sell around 8 million additional iPhones in 2011. We believe the main risk for Apple remains the component supply related issue. Although many in the industry struggle with securing components and reliable production, this is a larger risk to Apple than its competitors Research in Motion (NASDAQ:RIMM), Motorola Mobility (NYSE:MMI) and Nokia (NYSE:NOK) given its rapid sales growth and size of the market for the iPhone.

In the recent earnings conference call, Apple management indicated that it could have sold more iPhones, but it faced some supply related issues. ^[2] According to Gartner, the iPhone’s market share increased at a much faster rate than its competitors during the period from Q3 2009 to Q3 2010. ^[3] Hence it will be important to see if Apple is able to overcome the raw material supply related constraints in order to boost iPhone sales.

The iPhone is the most valuable business for Apple and constitutes around 53% of the $420 Trefis price estimate for Apple stock, which is about 20% higher than the current market price.

Potential upside to Apple stock if it does overcome supply issues

The triggers for increasing iPhone demand are many. Apple announced this week that the iPhone 4 will be on Verizon’s (NYSE:VZ) network starting this month. Verizon has over 90 million subscribers in the U.S. with 30% market share. This could be a big trigger for Apple if Verizon’s network and subscriber base embrace the coveted smartphone in earnest.

Asian demand for the iPhone is another trigger. According to the management, revenues from Greater China (mainland China, Hong Kong and Taiwan) for the last quarter was $2.6 billion, which was up 4x from the prior year quarter. ^[2] Things are certainly moving in the right direction, except that Apple now needs to ensure it can source components for these phones and make theme in order to meet demand. Here is the statement from Apple’s COO Timothy Cook who talks about the supply related issues:

We are working around-the-clock to build more. I feel great that the demand is so high, but at this point, I’m not going to predict when supply and demand will meet. We believe the reaction and results from the Verizon customers will be huge, and so I don’t want to give a prediction right now when the supply and demand will crawl. ((ref:2))

Management does not give details on which particular components it is facing the supply related issues. A few weeks back, we covered a story on the top 5 component suppliers of Apple, through which we estimated that Apple is expected to spend around 30% of total direct costs on these suppliers in 2011 (See 5 Component Suppliers Will Get $17 Billion from Apple in 2011).

We estimate that Apple will be able to sell 68 million iPhones in 2011, up from 48 million that it sold in 2010. In terms of the global mobile phone market share, we expect it to increase from 3.1% in 2010 to 4.2% in 2011. However, if Apple is able to meet the new demand and if we assume that Apple’s iPhone sells an additional 8 million in Asia (as estimated by Sanford Bernstein), Apple’s market share could be around 4.7% for 2011.

Using the modifiable chart above, this would add upside of just under 5% to our price estimate for Apple stock.

You can see the complete $420 Trefis Price estimate for Apple stock.

1. Barron’s report on Apple: Bernstein Sees Expanding iPhone Deals In Asia, January 2011 [↩]
2. See SeekingAlpha: FY Q1 2011 earnings conference call transcript, January 2011 [↩] [↩]
3. Gartner mobile phone report, November, 2010 [↩]