Saturday, May 19, 2012

The Apple June Quarter Halftime Report

On Friday, May 18th, AAPL ended the week's trading at $530.38 per share, down 17.5% from the all-time high of $644 per share set on April 10th in intra-day trading. Although at Friday's closing price the shares are up 31% on the calendar year, the current price-earnings multiple of less than 13 times trailing 12-month earnings of $41.04 is at the low end of the trading range established over the most recent six calendar quarters.
The current low valuation is remarkable considering Apple's 63% revenue growth over the most recent four fiscal quarters and corresponding eps growth of 95.5%. Additionally, there is over $116 in cash and marketable securities standing behind each outstanding share.
For long-term investors, Friday's closing price represents an unreal acquisition opportunity ahead of the pending Mac line refresh, the release of the successor to the iPhone 4S and the eventual addition of China Mobile as an authorized iPhone carrier. Each of these events will have a stimulative effect on the share price as Apple journeys through the next twelve months.

The Apple June Quarter Halftime Report
This past week we passed the halfway point in Apple's June quarter that ends on Saturday, June 30th. Today, I'd like to share my early expectations for each of Apple's major product lines in the quarter.
The Apple iPhone
In the March quarter Apple reported an impressive 88% iPhone units growth rate for the period. But the 35.064 million iPhones reported sold included an increase of about 2.6 million units in channel supply to 8.6 million. Management reported residual demand for the iPhone 4S in the Asia-Pacific region during the March quarter conference call with analysts, but the channel supply number will need to be reduced as Apple prepares for the launch of the successor handset.
The iPhone 4S is the most popular iPhone handset Apple has ever produced. But the product may have peaked during its introductory quarter and I have doubts the product can hold the world stage for a full 12 months as Apple's flagship handset. I expect a dramatic decline from the March quarter's iPhone unit sales growth rate of 88% in the June quarter as the drawdown of channel supply will impact reported unit sales and as public attention begins to turn to expectations for the next iPhone handset. 

In the first two quarters of FY2012, Apple sold more than 72 million iPhones. Apple successfully met global demand over this period while realizing an almost 107% increase in unit sales. Apple's next challenges are acquiring component supplies and ramping manufacturing capacity for the successor to the iPhone 4S. The new model will most likely sport a new form with other major hardware advancements making the manufacturing transition more challenging than the transition to the iPhone 4S.

Although the pace of global smartphone adoption has reportedly slowed, the addition of new carriers and Apple's increasing product presence in developing markets will support continuing strong growth for the iPhone line through the release of the successor flagship handset. The next flagship handset will sell on a scale not seen before even by iPhone standards. But the next quarter for "blow out" iPhone sales numbers may be the holiday quarter or first fiscal quarter of FY2013.

The Macintosh
In the first six months of the current fiscal year, Mac unit sales rose a respectable 16.73% to 9.215 million units. The backdrop of slowing global growth in PC shipments makes the performance all the more impressive.
At the end of the March quarter, Macintosh channel supply had fallen to between 3 to 4 weeks of supply, below the target range of 4 to 6 weeks. Additionally, a refresh of the iMac and portables lines has long been expected. 
The March quarter's 7% Mac unit sales growth rate was influenced by Apple's decisions about channel supply and rising sales of the Apple iPad. Management mentioned during the March quarter conference call with analysts K-12 school districts in the US purchased twice as many iPads in the period as Macs and the company expects robust iPad unit sales growth in the June quarter in the education market. The K-12 market has been a bright spot for Mac sales over the past few years.
Although the iPad will have a much greater impact on sales of Windows PCs than Macintosh PCs, the migration of K-12 districts to iPads from both Macs and Windows PCs will influence the June quarter's Mac unit sales numbers. The pending Macintosh product line refreshes, increasing traffic to Apple retail stores and the expansion of channel supply following the new model transitions will all positively influence the Mac's unit sales results. I do expect the Mac's average rate of unit sales growth to slow in the coming quarters from what has been realized over the past eight quarters as the Apple iPad moves beyond its nascent phase of global market development.
The Apple iPad
Apple's March quarter iPad unit sales of 11.798 million units represented a 151% unit sales growth rate and raised the unit sales growth rate for the first two quarters of the fiscal year to about 126.5%. The good news from the March quarter is that iPad sell-through was greater than reported sales as Apple reduced channel supply to about two million units, allowing for higher reported unit sales through the June and September quarters as production of the new iPad catches up with demand. I expect a very strong iPad unit sales growth rate again in the June quarter and for the unit sales growth rate for the first three quarters of the current fiscal year to remain well over 100%. The iPad will have the greatest influence of all of the company's product segments on Apple's rate of revenue growth in the period.
Other Products and Services
In the June quarter, I expect the revenue segment inclusive of iTunes and the App Store to reach beyond $2 billion in revenue for the third consecutive quarter while revenue generated from iPod sales to fall close to the $1 billion mark. The iPod line has now become almost immaterial to results in all but the holiday quarter of each year. 
For The June Quarter
Although I currently forecast a slight sequential gain in revenue for the June quarter, I expect earnings per share to come in well below the $12.30 Apple reported in the March period. This is due to an anticipated drop in overall gross margin as the Apple iPad contributes a much higher percentage of total revenue accompanied by an expected sequential drop in reported iPhone unit sales. I expect the rate of revenue growth in the June quarter to be below the 66.35% rate for the first six months of the fiscal year and below the 58.86% revenue growth rate in the March quarter. The Apple iPad will be the definitive revenue growth story in the June quarter.
At present I have a $790 price target on the shares and expect a retracing to the all-time high by late summer and for the shares to break through $700 following the successful release of the successor to the iPhone 4S handset. 
As the founder of the Braeburn Group of independent analysts, I am working with my fellow analysts on a 12-month AAPL price target index and full revenue and earnings estimate index for the June quarter. The Group's work will be published as we approach the end of the fiscal quarter. 
Robert Paul Leitao
Disclosure: The author is long Apple shares