Monday, January 28, 2013

Stock Focus: Apple

Apple's stock price tumbled by more than 10% in after-hour trading on Wednesday, post earnings release. Does it make sense? I don't think so. Let me walk you through the figures and I'll tell you why I think the stock is worth considering at this point.

Record Quarter

Fiscal Q1, from October to December, is the most important for Apple as it encompasses the holiday season during which retail sales are the strongest. They managed to generate $54.5 billion in revenues and $13.1 billion in profits in the period, a new record for the Cupertino based tech company. With that quarter's profits alone, Apple would be #12 in Fortune 500's ranking (which is based on annual figures). They also earned more in 3 months than what Intel, P&G or Citi achieved in the whole of 2012 (check for yourself). 

Strong sales and revenues progressions Year on Year

Below are three tables showing key products/segments evolution between Q1'12 vs. Q1'13. I took the info from Apple's website (here) and made an important adjustment by re-scaling the figures to weekly averages. This is crucial as Q1 2012 spanned over 14 weeks vs. 13 for 2013 and one would miss the company's real achievement by using gross quarterly data. We will use the "YoY (scaled)" column to assess the business evolution.

Table 1

Table 2
Table 3

Here are some of my observations mixed with takeaways from the analyst conference call (replay here) to put the figures in perspective:

  • iPod is losing:  well advanced in its life cycle, the dominant mp3 player is also suffering from cannibalization from the iPhone.
  • Mac got hit: this was due to supply constraints during the whole quarter; this should not be an issue anymore in Q2. Broadly speaking, PC demand is weak and Mac is also being cannibalized by the iPad.
  • iPad is a winner: Solid quarter with 22.9m units sold, a 60% increase compared to last year. iPad mini did well in reaching its audience but it also exerted pressure on the average selling price for the segment which fell from $535 to $466. Expect this to continue going forward (Tim Cook's words).
  • iPhone remains the king: still high and totaling 56% of the revenues with 47.8m units sold. The iPhone 5 introduction was a success and the fastest roll-out ever. All iPhones (4, 4s and 5 series) were in supply constraints during the quarter but sales remained very strong. Average selling price is slightly rising YoY, from $636 to $641.5, this is another sign that the iPhone 5 is doing well.
  • China stands out: the country is a big contributor to growth. Even if it still represent a third of the US in sales, it is growing at an amazing 80% rate. Apple is serious about it: Tim Cook paid a visit some weeks ago and was in talk with China Mobile, 4 new stores were opened, premium re-sellers doubled to 400, iPhones point of sales increased to 17,000 from 7,000. There is however no clear plan for an "iPhone mini" that many see as essential to compete with popular and cheaper competitor devices running on Android. 
  • Margins erosion: Gross margins fell to 38.6% from 44.7% a year ago. This is in part due to supply chain issues that will improve going forward but the erosion could persist for a while because of the current product mix. The iPad mini's margins are "significantly below" the company's average and selling more of it at the expense of the iPad means less dollars in per product out. The guidance for Q2 is for a Gross Margin between 37.5% and 38.5%, edging lower.

Good entry point

The figures above do not scare me. I see a company that is cashing in huge amounts of money and those amounts will remain huge even if growth and margins decrease gradually.

Let's be mentally flexible and imagine that Apple doesn't grow revenues this year. If this zero growth scenario would hold, we could take the $44.15 EPS from last year as an excellent proxy for 2013. If Apple is a falling star and if this zero growth period would then morph into an extended period of sluggish results going forward, we would maybe not pay more than 8x earnings to acquire it, so the price would be $353. Adjust this for the cash pile of $137bn, an add-on of $145 per share, and you get a fair price around $498. This is a quick and dirty valuation process but when you look at Friday's close at $439, this kind of make you think.

Even in a zero/sluggish growth scenario the stock looks cheap. I do believe that the track record of Apple means something for the future, innovation is still a key element that could make a difference. Tim Cook said during the call that the pipeline is "shock full" and that they "feel great" about what they have in store. I don't know what it is, I don't want to speculate, but at the current price the stock comes with a free call option on good surprises.

People get emotional when talking about Apple and they are fast to react on rumors. Selling in panic below $450 is like buying euphorically at $700 or above, it's a dangerous game. I see more upside than downside on the stock currently.

Disclaimer: I do not own Apple shares and do not intend to go long in the next 72 hours. It is just my job to keep abreast of the company's news flow.

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