Apple Watch: Is It High-Margin or Not?

By Markets Fool.com

Devices in the Apple Watch Edition line sell for as much as $17,000. Image source: Apple

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Apple's newest product is here! After a large buildup, Apple's first post-Jobs product -- the Apple Watch -- arrived in stores on April 24. Three days later, during Apple's second-quarter conference call, CEO Tim Cook commented on the watch's reception as being "overwhelmingly positive," with demand being greater than supply. Although it's early, Apple's smartwatch seems to be -- by all accounts -- another strong product for Cupertino.

Its effect on Apple's margins, however, seem to be up for dispute. On one hand, numerous reports, including the newest IHS Supply data, seem to show that the unit will increase Apple's highly monitored gross-margin percentage. On the other hand, there was a curious comment by Apple CFO Luca Maestri that guided down gross margins from the current figure of 40.8% to a third-quarter figure of 38.5% to 39.5%. The reasons given were that foreign-exchange headwinds from a strengthened dollar and Apple Watch margins "will be lower than the company average."

What does this mean? There are a plethora of third-party estimates showing Apple Watch will have higher margins than most of Apple's products, while Apple states it won't. Who's right?

IHS data: Lowest ratio of hardware costs to price
If research firm IHS is correct, Apple Watch Sport 38 mm has the lowest ratio of hardware costs compared to retail price of any Apple phone it has researched. After performing a teardown and pricing the components, the firm estimates the cost of its bill of materials is $81.20, with the cost rising to $83.70 when the manufacturing cost of $2.50 is added. Using the $349 retail price of the Apple Watch Sport, IHS figures estimate hardware costs are 24% of the manufacturer's suggested retail price.

This is compared to other Apple products that come in with hardware costs to price ranges of 29% to 98% (lower is better). The IHS breakdown looked at Apple's cheapest unit, with the mid-level Watch line starting at $549, and the top-end Watch Edition line fetching $10,000 per unit.

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These aren't the only analysts with lofty expectations for Apple's Watch. As fellow Fool writer Ashraf Eassa reports, Katy Huberty from Morgan Stanley pegged the watch with a gross-margin percentage of 45%, and Think Big Analytics estimates the gross margin somewhere in the 60% range.

It's important to note that hardware costs aren't the same as gross-margin percentages. For a few differences, gross margin generally includes warranty expenses and shipping and logistical costs, among others, whereas general hardware costs do not include these expenses. It's entirely possible these items are larger for an entirely new product.

Tim Cook: Third-party estimates are wrong
In addition to the difference in metrics, there's another explanation for the divergence between third-party estimates of bill of materials costs and Apple's C-suite comments. The third-party estimates could simply be wrong. According to Cook, that's perhaps the best reason for the differences.

During a follow-up question from Sanford Bernstein's Tony Sacconaghi, Tim Cook addressed third-party cost estimates by saying:

And I haven't even seen this, but generally, there's cost breakdowns that come out around our products that are much different than the reality. I have never seen one that is anywhere close to being accurate. And so, if that's the basis for your comment, I'd really dig into the data if I were you.

It appears Apple's watch won't be too much of a drag on gross margins if Tim Cook is correct. The company is still guiding for 38.5%-39.5%. Apple's generally conservative with its margin guidance, and the low end is close to Apple's gross-margin percentage total last fiscal year (38.6%). In the end, it appears the larger, higher-margin iPhone will continue to be the biggest driver of Apple's margins.

The article Apple Watch: Is It High-Margin or Not? originally appeared on Fool.com.

Jamal Carnette owns shares of Apple. 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.