Apple Conviction Sinks at Goldman Sachs (Update 2)

Updated from 10:10 a.m. EST to provide more analyst comments regarding iPhone unit cuts in the the ninth paragraph.

NEW YORK ( TheStreet) -- Just when you thought it was safe to go in the water with Apple ( AAPL), Goldman Sachs says wait a minute.

The New York-based investment bank removed Apple from its Conviction List, cutting its price target to $575 from $660, citing concerns about market share and new user growth. Goldman also lowered its earnings outlook on Apple for the calender year to $44.64 per share, down from $47.29.

Of particular note, Goldman said Apple is likely to miss consensus estimates for both the March and June quarters. Analyst Bill Shope lowered his 2Q estimates to $39.4 billion in sales and $8.88 per share in earnings, down from $42.69 billion and $10.26 per share, respectively. Shope also cut his iPhone and iPad estimates, and now expects Apple to sell 30.9 million iPhones, down from 33.4 million, and 18.4 million iPads, down from 22.4 million in the June quarter.

Shope noted that the iPhone 5 has been less successful than he previously estimated, generating fewer new users and fewer people upgrading to the new handset. the Goldman analyst cut his estimates in the June quarter on the notion that customers will wait to replace their current phones ahead of the pending iPhone 5S, and that Apple will aim to cut inventory at retail outlets such as Best Buy and Verizon to bolster sales of the new product.

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"Despite our optimism on this front, we believe the stock's outperformance over the next 12 months will be more closely tied to whether or not the company's next product cycles can reinvigorate market share momentum and installed base growth," Shope wrote in his report. The Goldman analyst is nonetheless optimistic that a new iPhone, iPad and perhaps other products will reinvigorate Apple's growth and its user base.

Tor the moment, the timing is uncertain. "Until this uncertainty is resolved, the stock's upside potential should be more limited than we previously anticipated," wrote the analyst.

Shope also notes that he expects Apple to introduce a low-cost iPhone around the third quarter of this year. Recent rumors suggest Apple will refresh the iPhone in this time frame with the iPhone 5S, and perhaps a low-cost iPhone as well. Other Wall Street analysts have mentioned low-cost iPhones as being a likely product, so there appears to be some credence to this message. A low-cost iPhone could provide "substantial upside to our unit expectations in the back half of the year and into 2014" as Apple brings more customers into its ecosystem.

There have been concerns that a lower-priced iPhone would not be as good as the current one but CEO Tim Cook said, "The only thing we'll never do is make a crappy product. We're going to make a great product. And so that's the only religion that we have is we must do something great, something bold, something ambitious."

Shope also said Apple "could reinvigorate its high-end momentum" with a larger iPhone. The iPhone 5 has a four-inch screen while the recent Galaxy S4 from Samsung, which runs Google's ( GOOG) Android operating system, has a larger screen. Cook has squashed the idea of a larger iPhone in the past, saying Apple has done extensive work and feels a four-inch screen is the right size.

In addition to a refreshed iPhone, Shope also expects Apple to update its iPad products in the second quarter.

"This will be a critical refresh as it will allow for channel fill in the June quarter and it has the potential to slow some of the cannibalization effects from the iPad mini," Shope said in the note. The tremendous success of the iPad mini has weighed on the larger iPad, which has hurt the company's gross margins, due to lower cost. The iPad mini starts at $329, while the 9.7-inch iPad with Retina Display starts at $499.

He now believes the iPad mini could account for as much as 53% of total iPad sales in both 2013 and 2014. That's way up from previous estimates when Shope expected the iPad mini to account for 31% of iPad sales in 2013 and 27% in 2014, respectively. The Goldman analyst remains cautious "on traditional iPad demand unless we see data suggesting the next refresh is indeed reinvigorating demand in this category."

There has been much discussion about Apple's $137 billion in cash, with shareholders calling for a much larger return of cash. Activist investor David Einhorn called for Apple to issue preferred stock, called iPrefs, to unlock the value of Apple's cash. Cook has stated in the past Apple is in "very, very active" discussions on what to do with its billions.

If or when Apple does announce a new capital allocation plan, Shope said this could provide "a healthy floor for the stock price." Should Apple use its international cash, Wall Street may be pleasantly surprised.

Concerns over innovation are nothing new with Apple, and as a result, investor sentiment has drifted lower. Recent rumors have focused on the possibility Apple could expand its product offerings by moving into smart watches and television. Dubbed the iWatch and iTV, Shope said that these new products could expand the company's platform allowing it to further monetize its user base.

Recent reports have put the iWatch as being more than likely, with Bloomberg reporting the company has a team of 100 people working on the product.

Apple shares were higher in early market trading, up 1.3% to $434.48.

-- Written by Chris Ciaccia in New York

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