Jahanara Nissar

After an initial surge in the China domestic market in September/October, the availability of the Huawei’s highly publicized Mate60 premium smartphone seems to have largely melted away. Why? We believe Huawei may not have been able to sustain supply of its Kirin9000 modem chip. And why is that? We believe it is due to inadequate yield of the Kirin chip at SMIC foundry.

Ever since the Mate60 model launched to much fanfare in China, AAPL investors have been mindful of the challenge from a newly resurgent Huawei. Though AAPL stock has perked up of late on macro tailwinds, on a 6-month basis the stock has underperformed the Qs, as the damage done to the stock from China fears persist. Market research reports and consumer surveys have left investors fearing share loss of the iPhone15 to the Mate60 in the China market.

At a House committee hearing two days ago, a senior member of the Commerce Secretary’s staff testified that the ‘neither the performance nor yield’ of the silicon in the Mate60 ‘may match the market of the device’. We wish to highlight the statement. The finding presented at the testimony appears to be the first public disclosure of the US government’s investigation into the Kirin chip.  We believe the statement is significant and has positive implications for AAPL.

Going into the 4FQ earnings event, the stock hit our $170 PT that we had set three months before (link). The gain in AAPL stock after the earnings event has been largely due to macro tailwinds. Of the big tech peers, we think investor expectations are the most muted for AAPL. With the Fed Chair yesterday markedly shifting towards a neutral policy stance, we think AAPL has more to gain than its big tech peers.

Going forward, whatever may be the headwinds the iPhone15 faces, we have come to view that the Mate60 is not one of them. If investors layer on top of the macro story, diminishing idiosyncratic risk from China/Huawei, we think AAPL could see a nice run-up into year-end.

We are turning modestly positive on the stock and raising our PT to $220 as we nudge up our Dec quarter iPhone expectations slightly ahead of consensus. Our FY24 revenue growth estimate creeps into positive territory, while still below consensus. We will however temper enthusiasm by noting that an earlier than usual seasonal shutdown of a Foxconn factory may not bode well for the March quarter.

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AAPL – muted investor sentiment: In a note titled ‘Investor expectations need resetting’ we published more than a year ago, we called out FY23 revenue down 1.5% vs. consensus up 4.7% at the time (link). A year later the company printed FY23 revenue down 2.3%, slightly worse than our estimate and significantly worse than consensus. After four quarters of negative revenue growth in FY23, investors have reconciled themselves to expect little to no growth. The guidance provided for the December (1FQ24) quarter did little to enthuse investors. Investor expectations have indeed reset from the go-go days of iPhone 12/13. While consensus calls for FY24 revenue up ~4%, we wonder if there is much conviction in the estimate. The China/Huawei risk adds to the gloom.

In our view, going forward whatever may be the headwinds the iPhone15 faces, we believe the risk of share loss to the Mate60 is not one of them as there isn’t adequate supply of its modem chip Kirin9000. In the context of muted investor expectations, reduced idiosyncratic risk out of China/Huawei could send AAPL stock off to a nice run-up into year-end.

Why would Mate60 modem chip have yield and performance issues?

• Yield: We believe the potential for yield issue is due to the Kirin9000’s large die size and complications arising from printing 7nm features using older generation 28nm fab equipment. The quadruple exposure on the stepper tools needed to reduce native 28nm feature to 7nm, results in die size larger than if the chip was processed on native 7nm technology. Larger die leads to lower yields.
• Performance: Why would the performance be lower than traditional 7nm modems out of say TSMC? We think the Kirin9000 transistor is based on planar architecture vs. the typical FinFET architecture used in traditional 7nm process. This difference could result in higher leakage currents, a critical metric in benchmarking transistor technologies.
• Indirect evidence of low output of Kirin9000 chip out of SMIC: Given the large die size of the Kirin chip, Huawei orders to SMIC should have translated into high sequential revenue growth at SMIC. But it apparently hasn’t. SMIC printed Q3 below-expectations and provided disappointing Q4 guidance.

Thoughts on the Mate60: We believe Huawei’s Mate60 is intended to demonstrate China’s ability to produce 7nm chips using older generation equipment. This ability may have military applications, thus triggering a US government investigation. However, for consumer products, which require high volume at high yields, the SMIC process may not be capable of producing silicon on the scale required to move the needle for AAPL iPhones. Insofar as Apple’s iPhone15 is concerned, we think the Mate60 is a paper tiger.

Bookend the iPhone upside – Foxconn action raises a red flag: Our checks show that the Schengen iPhone factory may have furloughed its workers as early as in mid-November which is unusually early for its seasonal shutdown ahead of the Chinese New Year. Part of the reason could be to decommission and move out manufacturing equipment to new geographies, such as Vietnam and India. And a part of the reason could be due to lack of iPhone order visibility into the 1^st half of CY24, potentially a red flag.

And yet, on the positive side:

• The China market could be seeing a modest resurgence for high-end smartphone models as mobile gaming makes a comeback. The iPhone15 and Xiaomi’s X14 could benefit from the trend.
• US telco carriers are left with little option on the premium end as Samsung has not refreshed its Galaxy flagship in ~2 years. Therefore, carriers are having to spend marketing $s promoting iPhone 15.
• Even pre-paid vendors in the US, such as Cricket, are promoting Apple’s flagship this year vs. their usual preference for refurbished models. We suspect Apple got rid of a lot of iPhone11 inventory at the end of the June quarter, resulting in reduced availability of refurbished models. This is a positive for iPhone’s overall ASP.

Raising AAPL PT to $220 from our $170 PT we set back in Aug’23 ahead of the June quarter earnings (link). Heading into the Sept quarter earnings, the stock hit our previous $170 PT. It has since then run up largely on macro tailwinds. However, the risk of share loss to the Mate60 risk has remained a concern for investors. Were the concern to go away we expect AAPL’s Dec consensus estimates to go up.

For the December quarter we model iPhone and overall revenue ahead of consensus. We are tweaking up our Dec iPhone revenue growth from up 2% to up 7.5% vs. consensus of up 5% (Exhibit 1). We model overall Dec revenue up 2.8% vs. consensus up 1.7%. For the fiscal year 2024 though, we are model iPhone and overall revenue below consensus (Exhibit 2). We model iPhone revenue down 0.5% vs. consensus up 3%. We are modeling overall earnings for FY24 at $391bn/$6.4 with revenue up 1.9% vs. consensus of $397bn/$6.56 with revenue growth up 3.7%. Our $220 PT is based on 34x to FY24 eps.