Is Apple on the Verge of Major Profitability Growth?

Ashraf Eassa, The Motley Fool

Updated Tue, May 15, 2018, 6:21 PM

Every computer that Apple sells includes two key components: Dynamic Random Access Memory (DRAM), which can be thought of as the workspace for a computer processor, and storage, which is where all programs and data are kept. Virtually all of Apple's computers use a type of memory known as NAND flash for storage.

Apple's iPhones arranged in a mosaic pattern

Image source: Apple.

Since DRAM and NAND are such important parts of Apple's computers, and since the amount of DRAM and NAND that the company offers in its key products tends to increase over time, the profitability of Apple's products depends substantially on market pricing for these components. When they're cheaper, Apple can either enjoy higher profitability or pass its savings onto the consumer (which could lead to higher unit demand). When they're pricier, either Apple's gross profit margin suffers, or it has to price products high enough to protect profitability at the expense of potential unit demand.

High demand and relatively low growth in supply of both DRAM and NAND in recent years has led to price increases for both; this has affected all buyers of these components, Apple included. However, according to Apple CFO Luca Maestri on the company's most recent earnings call, the situation could improve soon.

Peak NAND

"On the memory front, we feel that for NAND, we're going to be turning the corner very soon," Maestri said. Although he didn't elaborate further, a look at what's going on in the industry would seem to support his optimism.

NAND, like any commodity, sees pricing fluctuations based on supply and demand. NAND demand has continued to grow because many computing applications, from smartphones to data center servers, are incorporating more NAND flash.

As an example, Apple's iPhone 7 series came in storage configurations of 32 GB, 128 GB, and 256 GB, which represented increases from the 16 GB, 64 GB, and 128 GB configurations of the prior-generation iPhone 6s series, respectively. The iPhone 8 series and iPhone X shook things up further, coming in 64 GB and 256 GB configurations.

Some smartphone vendors are already introducing devices with 512 GB of storage, and I wouldn't be surprised to see Apple's upcoming iPhone lineup include a 512 GB option as well.

Although NAND demand continues to grow, many NAND flash producers are bringing additional supply online. Micron (NASDAQ: MU), for example, recently began construction of another NAND flash factory, and Samsung (NASDAQOTH: SSNLF) is reportedly considering building another one as well.

With supply set to increase -- potentially dramatically -- there's reason for Maestri to be optimistic that NAND flash pricing could be headed in the right direction to boost Apple's profits: down.

DRAM is "near the peak"

While Maestri's comments that NAND could be "turning the corner very soon" indicate that management expects NAND prices to start falling, his commentary around DRAM seems a little less optimistic: "For DRAM, we also think that we are near the peak, possibly at the end of the year," he said.

Although the situation in NAND hasn't been great for buyers, the situation in DRAM has been even worse. There are fewer major DRAM makers than there are NAND flash makers, and the DRAM market is much larger than the one for NAND. On top of that, the few DRAM vendors have been extremely careful about the amount of capacity they put in, lest they find themselves in a situation where overall industry supply outpaces industry demand, leading to DRAM price cuts.

In fact, they've been so careful that law firm Hagens Berman recently filed a lawsuit against the major DRAM makers, accusing them of illegal price fixing.

Although Maestri doesn't seem to be predicting DRAM price declines in the near term, he did suggest that DRAM prices would peak by the end of 2018. If DRAM prices might start coming down in 2019, that wouldn't help boost Apple's profit margins for the remainder of the calendar year (if anything, the situation could actually get worse). But it could lead to more favorable comparisons for gross profit margin, and ultimately net profit margin, in the coming calendar year.

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Ashraf Eassa has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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Peak NAND

DRAM is "near the peak"

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