Does the Apple Inc. Watch Have a Margin Problem?

By Markets Fool.com

During the most recentAppleearnings call, company executives said that the gross profit margin percentage for the Apple Watch would be lower than the company average. To put this into perspective, Apple gross profit margins were 40.8% last quarter and are expected to be in the range of 38.5% to 39.5%.

Continue Reading Below

That suggests Apple Watch gross profit margins are below 38.5%, which may have come as a surprise to many -- it certainly was to me.

So much for those component cost estimates
Ahead of the April 27th earnings call, estimates generally called for high gross profit margins for the Apple Watch. Katy Huberty atMorgan Stanleyestimated that margins would be about 45%. The principal analyst at Think Big Analyticssimilarly believed margins could be in the 60% range.

Well, it turns out that those estimates were dead wrong.

Interestingly enough, during the earnings call, Tim Cook made it a point to highlight that the component cost breakdowns published on the Web of various Apple products are usually "much different than the reality." He even went so far as to say that he has never seen such an estimate that was "anywhere close to being accurate."

Margins should get better with time
During the call, neither Maestri nor Cook commented on their long-term view of Apple Watch gross profit margins, but he did note that early on, there are "learnings and these sorts of things." This suggests to me that as Apple improves the manufacturing yield of the Apple Watch, the cost per unit should come down.

Continue Reading Below

I do not think this was explicitly addressed on the call, but I suspect that if the Apple Watch ends up being a very high volume device, costs should come down. Not only should Apple benefit from increased manufacturing efficiency, but with higher volumes, Apple may be able to negotiate volume discounts on components with suppliers.

Should Apple investors panic?
I do not think that Apple investors have any need to panic due to the fact the Apple Watch is not going to be a margin monster coming out of the gate. The device is a totally new revenue stream for the company that complements its already incredible (albeit iPhone-dependent) business.

As long as Apple can sell a lot of units, and as long as it is selling them at reasonable margins, the Apple Watch will only contribute to additional profits. Even if the overall corporate gross margin comes down, total gross profit -- should the Apple Watch become a major revenue source for the company -- will increase.

The one thing that does concern me, though, is that investor expectations for both Apple Watch sales and profitability may turn out to be too optimistic. This means that even if Apple delivers impressive revenue and profitability with the device, it could still easily fall short of some of the great expectations that many have baked into estimates and forecasts going forward.

We will know more next quarter
Apple Watch related revenue should begin to show up in financial statements next quarter under the "Other Products" category. While the company does not break out profit by segment, we will be able to get a sense of the kind of revenue Apple Watch is bringing in, giving investors a baseline for future projections.

The article Does the Apple Inc. Watch Have a Margin Problem? originally appeared on Fool.com.

Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.