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Apple’s commitment to return $100 billion to shareholders has helped establish a floor for the stock around $400. However, with another quarter or two of lower earnings the stock probably won’t move meaningfully higher until new products are announced which now seems to be in September. If you have a year investment timeframe the shares should move meaningfully higher ($500 plus) as long as new products can move the financial needle (new products need to add at least 5% or more to revenue and EPS growth).
Apple still has some tough compares until it can show any kind of EPS growth. Depending on new products the December quarter is the first quarter that the company has a chance of showing double-digit revenue growth and in reality that may not occur until the June 2014 quarter. Gross margin compares may get easier in the December 2012 quarter and I wouldn’t ever expect to see gross margins above 40%.
I’m not very concerned that the company is dispersing so much money to shareholders vs. investing in new products. It has and should be able to generate enough income to fund R&D. I’d prefer to see the cash sent back to shareholders vs. leading the company to execute a large or series of large M&A transactions. Besides them not usually working out incorporating a large company into Apple’s culture would be extremely difficult.
I find it interesting and a bit disappointing regarding the comments that Apple’s innovativeness is gone since it hasn’t announced a new product category since the iPad three years ago. New products are tough to bring to market and new categories are very tough to develop especially when you need the volume that Apple does to make a meaningful financial impact. Yes, Apple needs to come out with a product or group of products in a new category but I’m not overwhelmingly concerned that it hasn’t been announced yet.
Tim Cook needs to go. Hogwash. This statement seems to have come up since the stock is down and the company hasn’t announced a new category of products. The stock had gotten so over-owned in 2012 and the company was executing above any kind of normal run-rate it was almost pre-ordained that it couldn’t live up to the Street expectations and would take a hit. Management typically gets too much credit when a stock has risen to extremes and too much blame when it falls.
Get over it. Apple’s huge revenue growth and high gross margins won’t be achieved again. The company generates too much revenue to grow much more than high single digits and margins have to stabilize for earnings to grow in the high single digits or low double digits. A succession of new products with huge markets (iPhones and iPads) occur very rarely much less within a few years of each other. Combine that with high gross margins and channel fill and the bar got set very high.
The stock is trading at a very reasonable if not low PE multiple of 11x calendar 2013 earnings and that is before the $153 per share in cash and investments are taken into account. For an investor with a year or more timeframe I believe the shares can get back into the $500’s and if the company announces new products that tap into new markets that are meaningful in size the stock can get back into the $600’s.
Revenue
Apple generated revenue of $43.6 billion, an increase of 11% year over year. Revenue was slightly higher than the Street’s estimate of $42.5 billion (CJ estimate of $42.5 billion) and was above guidance of $41 to $43 billion. The outperformance was largely due to iPad unit sales coming in at 19.5 million, up 65% year over year, with revenue of $8.7 billion.
I believe it was critical that revenue needed to be in the guidance range so it was a slight positive that it was above it. This will give analysts more confidence in forecasting Apple’s results.
Revenue guidance of $33.5 to $35.5 billion was disappointing since the mid-point has revenue declining 21% quarter over quarter vs. a decline of 11% a year ago and positive growth of 16% the previous two years.
The poor guidance is hopefully due to new products being announced sometime this quarter but not available until the end of the quarter or in the September quarter. Apple’s revenue has become volatile due to consumers waiting for a new product and holding off on buying current ones. Management could also be even more conservative than usual due to Samsung’s Galaxy S4 becoming available in the next few weeks.
EPS
March quarter’s EPS of $10.09 was a bit better than the Street’s $10.04 (CJ estimate of $9.90) and was toward the high end of the guidance range of $9.24 to $10.24 but was down 18% from last years $12.30 when gross margins were 990 basis points higher. Similar to revenue it was critical that Apple had its EPS hit in the guidance range and towards the high end.
Earnings guidance was very poor and estimates for the June quarter continue to ratchet down. Three months ago the June quarter’s EPS was $11.00, it was $9.08 before the company reported last week and the mid-point of guidance is $7.05. For fiscal 2013 EPS has moved from $47.80 to $43.65 to an estimate of $39.00.
Tim Cook comments on new products
Tim Cook had a number of comments about new products during the earnings conference call.
Tim Cook said, "some amazing new hardware, software and services that we can’t wait to introduce this fall and throughout 2014. We continue to be very confident in our future product plans" and "we’ve got a lot more surprises in the works.
"[We're] continuing to invest in innovative products and feel really, really confident about our product pipeline in both hardware, software and also our services," he continued. "We are working very closely with our manufacturing partners to execute what we feel is a very exciting roadmap."
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New products fall into two segments
There are enhancements to existing products and new categories. Not surprisingly Apple should be announcing new iPhone and iPad models later this year. The key for iPhones will be a larger screen which I believe is very much needed. Apple may tout that its four inch form factor is the best size but that is what one says when that is all you have to sell.
However, I’m not as convinced that the company has to come out with a lower priced version. Except for the iPod low price is not in Apple’s DNA and while it is best to cannibalize one’s own products the impact could be too great. The company has been able to position itself as the aspirational brand.
I turn to my iPad to check emails if I have both products with me. I would be interested in having a low-cost iPhone for phone calls and a few other apps while using an iPad for all the other functions and apps that come with the Apple ecosystem.
The iPad will probably get enhancements such as faster processors and wireless connectivity but I’m not sure that the Mini will get a Retina display. It is selling extremely well without it so why increase the manufacturing cost if it probably won’t materially help sales.
The key is a new category of products. Two ones that are often rumored are an Apple TV (to capture the largest screen that consumers use) and most recently an Apple watch (the smallest screen).
For Apple to make a difference in the TV space it could be in the delivery of content or ease of use. I don’t think getting into the physical TV product is a lucrative offering. TV’s have low or no margin and are not replaced very often. To maintain margins remotely close to what the company is generating a TV would probably have to be too high of a price for a large consumer adoption and that is for U.S. consumers much less worldwide customers.
I do believe that Apple is working on a wrist based device that could appeal to a fairly large population. It would almost assuredly incorporate fitness information such as Nike’s FuelBand and also include health information. Power and cost are probably the biggest hurdles to overcome but an Apple branded device could become the latest fashion item. Utilizing Bluetooth connectivity could enable the wrist device to display information while an iPhone or iPad offloads processing that requires more power.
Services or enhancements leveraging its iTunes store and iOS devices will also have an increased focus going forward. Apple never really describes what products or services it will introduce but Tim Cook probably came as close as Apple management ever has in talking about payments. He said ‘I think it’s in its infancy. I think it’s just getting started and just out of the starting block.’
iPhone
Apple sold 37.4 million iPhones in the quarter vs. 35.1 million a year ago. I was projecting 37 million while the Street was also at 37 million. Revenue of $23 billion increased 1% year over year and was 53% of total company revenue. Keep in mind that 37 million smartphones is over 400,000 built and sold every day for the quarter including Saturday and Sunday. It really is a very tough logistical challenge to have this quantity of product sourced, manufactured, distributed and sold.
Average selling Price (ASP) was the key metric for the iPhone in the quarter. It fell 4% from $642 to $613 quarter over quarter. This was driven by a higher mix of iPhone 4’s which have a lower price, a greater mix of 16GB iPhone 5’s and what appears to be lower prices for iPhones in other countries to get first time smartphone buyers to choose Apple vs. Android phones. Apple does seem to be very focused on getting the middle class of developing countries into the Apple ecosystem.
One of the key partnerships that everyone is looking for is a deal with China Mobile. It has been rumored for years and while I don’t have any particular insights it would not surprise me to NOT see a deal struck. A year ago China Mobile announced that 15 million iPhones were running on its network from users that had bought an iPhone and hacked it to work on its system. There may not be a lot of incentive from either China Mobile or Apple to strike a deal.
iPad
The iPad was the product that had the strongest results of Apple’s products. It sold 19.5 million units, an increase of 65% year over year, while the Street was estimating 18 million and I was at 17 million. Revenue was $8.7 billion, an increase of 33% year over year and accounted for 20% of total revenue.
Image via CrunchBase
From almost all the surveys that are being published the iPad is dominating tablet Internet traffic and generating the largest amount of revenue for third party app developers. While iPad ASPs have decreased dramatically from $667 in the September 2010 quarter to $449 in this quarter, down one-third, the company seems to have all the screen sizes covered and keeping rivals from making large inroads.
Mac
Mac units of 3.95 million were down 2% year over year with revenue of $5.4 billion, up 7% year over year. Macs accounted for 12% of total revenue and its ASP increased slightly from $1,359 in the December quarter to $1,378 in the March quarter.
While Mac units were down slightly they are doing much better than the overall PC market which saw a decline of 14% according to IDC. I suspect that Apple will be very happy to sell about 4 million Macs a quarter while it sells about 20 million iPads.
Gross margin
Gross margin of 37.5% came in at the low end of guidance of 37.5% to 38.5%. The Street was projecting 38.6% while I was at 37.8%. Keep in mind that a mid-to-high 30% gross margin is very good for a hardware oriented company. It came in lower than expected due to more iPad Minis being sold and a change to its service policy which forced the company to increase reserves in the March quarter for products sold in previous quarters.
Gross margin guidance for the June quarter is 36% to 37%. The key variable going forward is will Apple come out with a lower priced iPhone. If it does then margins will take another step down towards the low 30%’s since the iPhone accounts for over half of the company’s revenue. While it should help revenue growth and also grow net income I believe the Street could react negatively to an iPhone that cannibalizes higher priced iPhones.
Increased Dividend and Stock Buyback (But has to take on Debt)
Apple announced that it was increasing its dividend and stock buyback program from $45 billion to $100 billion through calendar 2015.
Its quarterly dividend will increase from $2.65 to $3.05, a 15% increase, for a yield of 3.0%. The dividend will cost the company over $11 billion in U.S. cash on a yearly basis. While stocks can always go lower a 3% dividend yield (or higher) should help set a floor on the stock.
The stock buyback program is increasing from about $15 billion to $60 billion. Based on spending about $5 billion per quarter Apple’s share count could decrease about 4% per year in fiscal 2014 and 2015.
A key factor to keep in mind is that the $100 billion has to come from U.S. cash which Apple only has $42 billon currently. About 70% of the company’s cash and investments are overseas. Additionally in the March quarter U.S. cash was essentially flat quarter over quarter. The company probably generated enough to cover the $2.5 billion spent on its dividend payment but no more.
So to return $100 billion to shareholders Apple will have to take on debt. If the company plans to keep lets say $10 billion on hand as a cushion and current cash generation covers the dividend then the company will need to raise about $30 billion in debt ($60 billion in share buybacks minus the $30 billion excess U.S. cash it currently has).
The company has received a AA+ rating from S&P and an Aa1 rating from Moody’s which are their second highest debt ratings. To get a feeling for what Apple may pay for debt Microsoft recently raised 5 year debt at a 1.01% rate, 10 year at about 2.4% and 30 year at around 3.9%. If Apple decides on 10 year or shorter debt than it will actually save cash since it will be retiring stock with a 3.0% yield and the debt interest payments are tax deductible.
Greater China
Greater China generated $8.2 billion in revenue or 19% of total company revenue. This was a reported increase of 7.5% year over year but when measured on a sell-through basis growth was 18%.
The company plans to double the number of Apple stores from 11 to 22 in less than two years and it currently has 19,000 indirect sales locations with plans to increase that number. Since China has 100 cities with one million or more people there is tremendous amount of opportunity for Apple to increase its retail base.
Greater China’s operating income decreased by $1 billion year over year from $3.8 billion (49.5% of revenue) to $2.8 billion (33.9% of revenue) while sales increased. This is probably an indication of the incentives that Apple is offering to drive iPhone adoption to try and stem Android sales.
Retail
The retail segment generated $5.2 billion in revenue, an increase of 19% year over year. This was a rebound from the 5% revenue growth in the December quarter.
Average revenue per store increased 8% year over year but the number of visitors per store dropped 3% year over year.
The company has been without a head of retail since October last year. It is a bit concerning that it is now almost six months without someone running the group. Tim Cook must be looking for someone outside of Apple otherwise he would have already announced an internal person.
Third Party App Developers
If Apple’s World Wide Developers Conference selling out in two minutes last Thursday is an indication of their interest in Apple it shows it is white hot. I was monitoring a Meetup group and there were a huge number of developers that were not able to register for $1,600. Canalys estimates that 74% of all apps sold worldwide were from Apple’s app store.
Apple has paid over $9 billion to developers since the inception of the App Store with $4.5 billion in just the past four quarters. The $4.5 billion translates to about $2 billion in revenue to Apple. While there is IT and people infrastructure to run the App Store it should be a fairly leveragable business model so the acceleration in this revenue stream is positive for Apple in not just the devices it sells but also the incremental profit.
Stock Chart Reading
Apple probably saw its bottom in mid-April when it closed at $390. While the stock is still in a downtrend based on the larger share repurchase and overall strong position for the company I believe the stock has made a bottom.
Disclosure: My family and I own Apple shares
