Tuesday, October 19, 2010

Apple (NASDAQ:AAPL): Colour on quarter..

Apple (NASDAQ:AAPL) is getting a lot of supportive commentary from the analyst community this morning after posting strong headline results on somewhat weaker gross margins which led the stock down around 6% in after hours trading.

I'll highlight only the more interesting ones:

- J.P. Morgan notes that shares of Overweight-rated Apple may come under near-term pressure, but it should be a phenomenon they expect to pass quickly. Gross margins of 36.9% were below Street consensus expectations of 38%. Meanwhile, iPad units came in below elevated investor expectations. Despite these bumps, Apple's meteoric revenue and profit growth and 14.1 million iPhone units should be enough for the bulls to keeping running. Market momentum stands to continue in each of the company’s three main products, and the absolute numbers should keep getting bigger. At 17.2x JPM revised C2011 EPS estimate, versus the peer group average of 14.2x, they believe Apple is trading like a value stock and not as the high-growth story in large cap equities.

Gross margins are a set-back, but absolute numbers should keep climbing. Gross margins came in better than company guidance of 35% but below the Street consensus estimate of 38%. Firm thinks investors will re-adjust for the gross margin setback and guidance, taking all in stride given the total revenue and profit growth profiles continue to rise. Competitive pricing by Apple in both the iPhone 4 and iPad weighed on gross margins, and costs related to a richer iPhone 4 feature set (i.e., Retina Display and Accelerometer) also were drags. During the earnings call, the company’s commentary indicated these factors would not dissipate.

Investors may have a mixed reaction to CEO's participation on the call. CEO Steve Jobs made a special appearance on last night’s quarterly conference call. Mr. Jobs passionately discussed the competitive environments related to the iPhone and iPad and answered analysts’ questions. JPM thinks that investors may have more questions than answers as to why Mr. Jobs participated on the call.

In firm's view, investors could speculate his appearance was a “smoke screen” to deflect attention from the gross margin weakness or lighter than expected iPad unit shipments. Alternatively, on a more positive note, they think that Mr. Jobs may have been on the call to trumpet the company’s break-out revenue performance, eclipsing the $20 billion revenue threshold on a quarterly basis, which is a major milestone. Lastly, Mr. Jobs may have been on the call to downplay the media hype related to the pending onslaught of competitive responses to the iPad.

On this last point, they believe that Apple’s iPad market leadership could be retained longer than Bears may fear. JPM notes they are skeptical of competitive tablets exhibiting any sort of similar adoption curve as the iPad’s. In JPM's view, the key factor driving the separation from other tablet vendors stands to be Apple’s access to content. With tablets, they think that offering a trove of applications, as is industry practice in smartphones, will not be enough. The ability of the user to access content, such as movies and TV shows, is more important for tablet users, and this is where Apple has fought hard to secure access to content.


- Bernstein notes Apple's FQ410 top-line and bottom-line results were very strong, handily beating consensus revenue and EPS. As a result they are raising estimates for FY11 to $20.49. iPhone sales of 14.1M units were significantly above expectations and led to the revenue beat ($20.34B vs. consensus at $18.8B). EPS benefited an estimated $0.23 from a lower than expected tax rate; ex- this adjustment, Apple still beat EPS (4.41 vs. 4.08) expectations by 8%. The company guided for above consensus revenue for only the fourth time in 11 quarters, reaffirming Bernstein's belief that Q1 should be a very strong quarter.

The big question is what happened to Apple's gross margins, which declined sequentially despite a huge mix shift to high-margin iPhone. Bernstein's analysis suggests that iPhone gross margins may have been 700-900 bp lower in FQ4 vs. FQ3 due to a sequential increase in iPhone 4 BOM of $40 - $50 vs. the iPhone 3GS. Given that Apple's guidance for Q4 appeared to have only forecast a decline in iPhone GMs of about 500 bps, the firm wonders if Apple was somehow blindsided by higher COGS, potentially as a result of extraordinary demand for the device. If true, then some of the GM pressure experience in the quarter could reverse going forward.

Bernstein's analysis suggests that iPhone GMs declined 700-900 bps sequentially, however they don't believe the margin decline can be attributed to either competitive pressures or pricing pressure from carriers (stand-alone handset ASP actually improved sequentially from $595 to $610); rather they believe this was due to an increase in BOM on the iPhone 4. The question remains whether Apple should have been more prescriptive/explicit in its guidance for gross margins in FQ4, or whether Apple was blind-sided by higher than expected COGS during the quarter, potentially because of extraordinary iPhone demand. Ultimately, Bernstein thinks it may have been a bit of both.

While Apple's stock was down over -6% in after hours trading and there will likely be strong debate among investors regarding gross margins, the net result is that Berntein has increased their FY 11 revenue and EPS estimates by 9% and 5% respectively, and believe that even if the iPhone 4 does have sustainably lower margins than its predecessor, its increased functionality has led to a step up in demand that is meaningfully accretive to overall earnings. Ultimately they believe Apple made a bet that significantly increased functionality on the refreshed iPhone would drive a step-function increase in demand, and that is exactly what has transpired. Whether Apple should have guided gross margins more carefully last quarter, or whether unprecedented iPhone demand blind-sided Apple and hurt margins are interesting questions, but the end result is that iPhone revenues and gross margin dollars were higher than the most ardent bulls had expected for Q4. Additionally, surging iPhone sales volumes are also strategically important in helping Apple secure its first-mover advantage vs. other device manufacturers

Investment Conclusion
Firm rates Apple outperform with a price target of $375. They believe that the stock is attractively valued (trading at an EV/FCF on FY 2011 results of less than 12x, in line to below the market) and consider it the most secularly attractive name in their coverage universe.

Notablecalls: The 1st line of JPM's comment is about as cautious as the analyst community goes on AAPL this morning. Everyone else is still very positive on the name. The stock traded as low as $294 after the halt last night and is now back above the $300 level this morning. While I don't have a strong view on the stock today, please consider the following:

- Over the past years Apple has been in the business of building a better mousetrap. The Mac, the iPod, the iPhone were all better mousetraps.

- And then cometh the iPad. The Pad's not a better mousetrap. It's a completely new one. Building something completely new is way more expensive than building something that is just merely better than the predecessor. This is what lies ahead for Apple - higher costs.

Again, I have no view on AAPL this morning. My brain (deductive logic) tells me to go ahead and buy the low $300's but my gut tells me to stay away as the bounce may not last long...

3 comments:

Stock Picker said...

all this attention on apple while google is ignored. quite bias.

notablecalls said...

yeah..cry me a river.really

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