Saturday, November 29, 2014

FY2015: Apple's Big Adventure

On Friday, November 28th, Apple’s share price closed the month’s trading at $118.93, up 9.9% from the opening price on November 3rd and up nearly 10.5% from the opening price on September 29th, the first trading day of the fiscal year. 

Recent analyst revenue upgrades and price target revisions have provided support for the share price. The current Wall Street consensus revenue estimate for the December quarter is $66.23 billion compared to management’s revenue guidance for the quarter of between $63.5 billion and $66.5 billion. However, the current revenue consensus estimate for FY2015 remains a decidedly conservative $210.68 billion and for FY2016 the revenue consensus estimate is a surprisingly low $223.02 billion.

In contrast, my revenue models suggest Apple may reach one-quarter trillion dollars in revenue in FY2016 following a revenue performance this fiscal year of $225 billion.

On November 19th Morgan Stanley’s Katy Huberty raised her firm’s price target from $115 to $126. She stated investors underestimate demand for the Apple Watch and is forecasting 30 million Apple Watches will be sold in CY2015. She also believes institutions remain underweighted in Apple shares. In my view, increasing institutional demand for shares will buoy the share price during the first six months of the current fiscal year.

On November 25th Aaron Rakers at Stifel Nicolaus raised his Apple price target to $130 from $115. On the same day Brian Blair reiterated his firm’s view iPhone unit sales will range between 72 million and 75 million in the December quarter. Although the share price may not go higher in a straight line, I expect a continuing series of analyst estimate revisions over the next several weeks to support the share price into Apple’s December quarter earnings release in late January. 

Looking Back
Although unit sales expectations for Apple’s iPhone 6 handsets are moving higher with strong evidence of a big market share shift in the high-end smartphone market from competitors to Apple, most analysts remain cautious on their FY2015 revenue and earnings per share estimates. 

The graph below illustrates Apple’s revenue mix for the fiscal year ended in September. In the 12-month period, the iPhone represented just over 55% of reported revenue. Combined, the iPhone and iPad lines represented over 72% of revenue in the period.
There’s no disputing the fact Apple’s rates of revenue growth slowed dramatically in fiscal years 2013 and 2014 following torrid rates of growth in fiscal years 2010 through 2012. 
Additionally, even with the ongoing $90 billion share repurchase program, earnings per share last fiscal year barely surpassed the outcome of Apple’s outsized FY2012 performance. Apple's current net income record set in FY2012 will finally be surpassed this fiscal year.
Moving Forward
Due in part to the recent slow rates of revenue growth, analysts generally remain cautious on the company’s FY2015 and FY2016 outlook. With months remaining until the spring debut of the forthcoming Apple Watch, few analysts (Ms. Huberty a notable exception) are willing to incorporate definitive Apple Watch unit sales estimates into their current revenue and earnings estimates. However, there are factors in play which will significantly boost Apple’s revenue and earnings performance this fiscal year even without definitive Apple Watch unit sales estimates.

FY2015: Apple's Big Adventure
With Apple’s high revenue concentration in the iPhone product line, strong unit sales growth this fiscal year sparked by the larger-screen iPhone 6 handsets will deliver big percentage and revenue volume gains to the company’s top line. In FY2014, iPhone unit sales rose a moderate 12.62% while reported revenue rose a more meager 6.95%. 

But there were factors last year that negatively impacted the rate of overall revenue growth. In the 12-month period ended in September, iPod revenue fell $2.125 billion, dramatically decreasing the rate of aggregate revenue growth. In this fiscal year iPod revenue will no longer have a material impact on the company’s revenue performance and the addition of the Beats line of products in the company’s results will deliver positive growth for the revenue segment that will be recast beginning this quarter. 

With iPhone unit sales volume expected to rise by at least 30% this quarter and by well over 20% this fiscal year, the iPhone product line alone will deliver double-digit aggregate revenue growth for the company. Even with expectations for another unimpressive year for iPad until sales, iPhone revenue this fiscal year may approach $130 billion versus the roughly $102 billion revenue performance for the product line in FY2014.

The iPhone line alone may deliver aggregate revenue growth for the company this fiscal year at twice the rate of revenue growth last fiscal year. Additional revenue sources such as the forthcoming Apple Watch will be wholly accretive to revenue and from the first dollar of sales will add to the reported revenue growth rate. I expect Apple’s aggregate revenue growth rate to more than triple year-over-year.

Apple’s Fully Diluted Share Count
Apple reported a fully diluted share count of 5.972 billion shares for the September quarter. However, the company averages the fully diluted share count each quarter. As of October 10, 2014, the company’s fully diluted share count stood at 5.865 billion shares. On a split-adjusted basis, Apple begins the December quarter with 7% fewer shares than were reported as the average fully diluted share count one year ago. 

As of September 27th, Apple had exhausted $67.9 billion of the authorized $90 billion share repurchase program. There were also shares remaining to be returned to the company under a $9 billion accelerated share repurchase program that began in August. Throughout FY2015, as the company continues to repurchase shares, earnings per share will rise at a much faster rate than the rates of revenue and net income growth. 

The current Wall Street consensus eps estimate of $7.72 for FY2015 is more than conservative, it’s downright low. Earnings per share estimates will steadily rise over the next few months as Apple begins to deliver record quarterly revenue, net income and earnings per share on a seasonally adjusted basis throughout the fiscal year. I expect earnings per share this fiscal year to reach $8.25 on $225 billion in revenue.

Apple’s Product Line ASPs
The graph below illustrates Apple’s average selling prices by product line for the last sixteen fiscal quarters. The elimination of the 32GB configurations of the flagship iPhone and iPad models as well as the $100 premium for the iPhone 6 Plus handsets will drive iPhone ASPs higher year-over-year. Even if iPad unit sales fall for a second consecutive year, a higher percentage of iPad Air models in the mix will boost iPad ASPs this fiscal year.
Net Income As A Percentage of Revenue
The graph below illustrates Apple’s net income per revenue dollar performance over the most recent twenty fiscal quarters. Although there’s no expectation net income per revenue dollar will rise again to FY2012 levels, net income per revenue dollar this fiscal year will most likely surpass the levels achieved on a quarterly basis in fiscal years 2013 and 2014

The graph below details the recent spike in operating expenses per revenue dollar. As Apple’s rates of revenue growth declined from the rates of growth achieved in fiscal years 2011 and 2012, operating expenses per revenue dollar moved higher. 

The rise in operating expenses per revenue dollar last fiscal year is also due in part to the recent spike in R&D expenses.
As Apple’s revenue growth rate this fiscal more than triples over the revenue growth rate of FY2014, operating expenses per revenue dollar will decline year-over-year. R&D expenses, though on the rise, are a harbinger of new and upgraded products to be delivered this fiscal year and next fiscal year as well. The reduction in operating expenses as a percentage of revenue this fiscal year will further boost the company’s net income and earnings per share performances. 

A Year Of Adventure For Apple And The Company’s Shareholders
Apple has embarked on the most successful year in the company’s history for revenue, net income and earnings per share. With a tripling of the company’s revenue growth rate, continuing reductions in the fully diluted share count and most analysts remaining cautious on their revenue and earnings per share forecasts at this time, FY2015 is a year of adventure for Apple and the company’s shareholders. 

Robert Paul Leitao

Disclosure: The author is long Apple shares