By Bill Rigby
(Reuters) - Apple Inc may notch its most successful holiday shopping season yet when it reports quarterly results on Monday, setting records for sales of its gift-friendly iPhones and iPads.
But it will continue to draw investor scrutiny over sales in ultra-competitive China, its No. 2 market but a drag on revenue and margins in recent quarters. The iPhone maker has been ceding ground to Samsung Electronics and other rivals there, but has now sealed a long-awaited deal to sell iPhones through China Mobile that could bear fruit in 2014.
Apple, which once routinely blew away Wall Street's most bullish expectations, needs a superb quarter to galvanize the stock. Its shares are down about 3 percent this year.
Activist investor Carl Icahn, arguing that at 13 times forward earnings the stock is undervalued, is building up his stake and demanding the Cupertino, California company share more of its $146 billion cash hoard.
Longer-term, investors want to see what new gadgets Apple can pull out of its hat, a central issue about which CEO Tim Cook has been cagey. Speculation revolves around a smartwatch, a larger-screened iPhone - a nod to Samsung's hugely successful "phablets" - and persistent talk of a TV product.
"Beyond fiscal 2014, it is not a slam dunk that Apple's net income will be higher in three to five years," said Bernstein Research's Toni Sacconaghi. "Without new product categories, we see Apple's end markets as increasingly mature and competitive, which could pressure or limit revenue growth and gross margins."
Samsung, reflecting how intensifying global competition is eroding smartphone profits and margins after years of explosive growth, on Friday reported its first quarterly profit decline in two years.
Sales-wise, Apple's current line-up is still expected to enjoy a strong following despite stiff competition from Samsung and Amazon.com Inc's Kindle Fire.
Wall Street analysts are expecting Apple to report sales of around 55 million iPhones and 26 million iPads, up from 48 million and 23 million respectively in the year-ago quarter.
Of that iPhone estimate, analysts expect good sales of the 5S due to pent up demand and limited supply around launch time, but remain less sanguine about a 5C that has so far failed to excite the cost-conscious consumers it targets.
A CHINA QUESTION
In the options market, traders were bracing for a move of about 5 to 6 percent in Apple's shares after its announcement. The sentiment was more bullish than bearish with call volume outpacing put contracts: of 1.87 million contracts of open interest in options, 1.17 million were calls and 706,000 puts.
Apple's stock is up 21.7 percent over the past 12 months, just ahead of a 20.4 percent rise in the Standard & Poor's 500. Still, that has disappointed some investors after the shares increased five-fold in the last five years.
In a lengthy letter to shareholders on Thursday, Icahn urged shareholders to approve his proposal for a new $50 billion share buyback, arguing the company did not need so much cash on hand and that the stock was undervalued relative to the S&P 500.
Apple, which launched a massive share buyback last year, has urged shareholders to reject Icahn's proposal, arguing that it needs sufficient reserves to tackle increasing competition in a fast-evolving mobile industry.
More fundamentally, investors worry about Apple's performance in China, the world's largest cellular market. Analysts say the high-end iPhone is struggling to make headway against cheaper local offerings from Huawei and Xiaomi, while Samsung continues to dominate the market.
But some analysts say the addition of China Mobile's vast nationwide network to the iPhone's stable could drive sales of four to five million iPhones in the March quarter.
"Inventory build and magnitude of China Mobile iPhone sales are a big X-factor for the March quarter," Sacconaghi wrote on Friday.
(Reporting by Bill Rigby and Edwin Chan; Editing by Chizu Nomiyama)