Saturday, December 1, 2012

Why Apple Will Beat The Street

Apple ended November trading at $585.28 per share. At the closing price on November 30th, the shares traded at 13.28 times trailing12-month earnings and off 17% from the all-time high of $705.07 set on September 21, 2012. In the ten weeks since the all-time high, analysts have reduced their expectations for the company's December quarter and the fiscal year ending in late September. The changes in analyst expectations have contributed to the recent downward pressure on the share price. 

Apple will beat the Street's revenue and earnings consensus estimates for the December quarter and the Street's consensus estimates for the current fiscal year. In today's article I will explore the factors that will deliver an earnings surprise when Apple's quarterly results are released in late January. I expect the share price to retrace to the all-time high by the first trading day of February 2013 through a gradual recovery of lost ground over the next sixty days. Management's eps guidance and the Street's consensus eps estimate are not supported by the company's earnings to revenue ratios measured over the most recent eight fiscal quarters. 

Apple's Guidance and Analyst Expectations
For the December quarter, management offered revenue guidance of $52 billion and earnings per share guidance of $11.75. Management's guidance suggests revenue growth of 12.23% over the prior-year period and a decline in eps for the quarter of $2.12 or 15.28% from the $13.87 in earnings per share achieved last year. Management is quick to remind analysts the prior-year period contained 14 weeks versus Apple's usual 13-week fiscal quarters. In contrast to Apple's very low guidance numbers, Wall Street analysts are currently expecting revenue of $54.52 billion, representing expected revenue growth of 17.68% and earnings per share of $13.30, representing an expected decline in eps of 4.10%.

Net Income Per Revenue Dollar
Using an estimated 950 million fully diluted shares outstanding as a constant, management's December quarter guidance suggests about 21.5% of revenue will flow to net income. The Street consensus is a bit more positive, suggesting 23.17% of revenue will reach the bottom line. In an article published in early November, I illustrated the percentages of Apple's quarterly revenue that reached the net income line over the most recent twelve fiscal quarters. There's a direct correlation between the percentage of net income per revenue dollar on a quarterly basis and the iPhone product cycle. The graph below illustrates the percentage of revenue that flowed to net income over the most recent eight quarters as a reference for the performance comparisons in today's article. 
Net income per revenue dollar tends to fall during the quarters in which Apple's flagship iPhone handset reaches the end of its annual cycle. Net income per revenue dollar tends to rise during the first two quarters following the annual iPhone refresh. This is because the iPhone has the highest gross margin among Apple's device lines and the quarters in which the iPhone represents the highest percentage of revenue also yield the highest net income per revenue dollar.

Apple's Rates Of Revenue And Earnings Growth
The graph below illustrates Apple highest rates of revenue growth occur in quarters following the annual iPhone refresh and in these quarters Apple delivers the highest net income per revenue dollar.
The iPhone 4 introduced a new handset form factor while the iPhone 4S maintained the same form factor for a second model year. Although the iPhone 4S generated higher gross margin than its predecessor, it had an abbreviated period of peak demand. The iPhone 4 maintained strong global demand into the June quarter of FY2011. The iPhone 4S peaked as a product early in the March quarter of FY2012. The falloff in iPhone 4S demand through the June and September quarters of the fiscal year reduced the company's rates of year-over-year revenue growth and diminished the percentage of revenue that flowed to the net income line.