Apple Profits Affected By Component Prices?

Posted by: Arik Hesseldahl on August 20, 2007

There’s a lot of buzz, as there is every year at this time, about component prices, and how they’ll fluctuate heading into the holidays. This is the time of year when companies like Apple are placing their orders for parts that will be used in products that will be on the shelves in fourth quarter. Prices on commodity parts like DRAM, flash memory and LCD screens have been pretty good for the most part, but they can’t stay so favorable forever. During Apple’s quarterly earnings call on July 25, Apple CFO Peter Oppenheimern and COO Tim Cook sought to tighten the reigns on profit guidance in part because of prices on those components that were starting increase. (See the transcript here.) Hewlett-Packard CEO Mark Hurd said much the same thing during its earnings conference call on Aug. 15, saying the benefits from low component prices would not be “sustainable in future periods.” He cited display panels as being “tighter than they have been.” (See transcript.)

So today word comes from Andy Hargreaves at Pacific Crest Securities in Portland, OR. that spot component prices are on the rise, and that will, no surprise, eat into Apple’s profitability just a bit.

Flash memory spot prices are on the the rise he says, so much so that profit margins on iPods could drop by 170 basis points, and by 50 basis points on the iPhone. Prices on LCD panels he says are up 8 percent, which could shave another 150 basis points off of Mac profit margins.

On flash memory, he reminds that Apple cut deals with several flash memory suppliers, including Toshiba, Hynix, Samsung, Intel and Micron for a steady supply of flash memory chips through 2010. Now Apple has never disclosed any information about the pricing arrangements. But here’s the interesting thing: Apple is the biggest purchaser of NAND-type flash memory in the world, save for SanDisk, which essentially supplies itself. Market researcher iSuppli figures that Apple will spend $1.8 billion on NAND flash for the iPod nano, iPod shuffle and the iPhone. That accounts for about one-fifth of the world’s supply, which means Apple gets some pretty good pricing leverage. Further, Apple’ is expected to consumer $2.4 billion worth of NAND flash in 2008. Hargreaves figures that Apple deal with these supplies is pegged to the spot price, which fluctuates, but includes a sizable discount, given Apple’s size. The next biggest consumer of flash memory behind Apple? Sony. Think about the implications of that statement for a moment. More on this after the jump.

So why the change in the pricing environment? Simple economics. There was too much NAND flash memory on the market, and so prices fell during the first half of the year, prompting chipmakers to slow down production and allow demand to catch up with supply, which led to prices firming up.

Meanwhile, prices on LCD screens are up between $5 and $11 per panel since June. Capacity is particularly tight on notebook displays. Notebooks, have been a huge strength of Apple's in the last two years. In third quarter, Apple sold 1.1 million notebooks, versus fewer than 800,000 in the year-ago period, a surge of more than 41 percent. (See a PDF summary of Apple's data here.)

All told, Hargreaves says these pricing changes would have been anticipated by Apple management, in no small part because they're part of the seasonal swing that happens every year, and Apple can stand the hit because sales volume is higher in the fourth calendar quarter (Apple's fiscal first quarter) than in other quarters. Still, a 100-basis point drop in Mac margins can reduce earnings per share by two cents. A 100-basis point drop in iPod profit margin can do the same thing. For the moment, Apple says its expecting to earn 65 cents a share in the quarter, versus the 92 cents per share it earned in its third quarter.

However Apple almost always promises little but delivers a lot. The average forecast of Wall Street analysts for the quarter is for Apple to turn in earnings of 80 cents a share. Hargreaves? For the quarter ending in September, he's expecting Apple to earn 88 cents a share, on revenue of just less than $6 billion. That compares with 62 cents on sales of $4.8 billion in 2006. So assuming all goes well, these surges in component prices will likely do little damage to Apple's overall profit picture. But they certainly bear watching.

Update: Here's more on the subject from the Associated Press, via The Sydney Morning Herald quoting a Samsung exec as saying that the company keeps raising its contract prices. Incidentally, one other thing this means is that if you're considering upgrading the memory on your current Mac, do it now before the prices get much higher.

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