Sunday, August 30, 2015

Apple And The Long Arc Of Time

“In the fiscal year beginning in late September, Apple will generate over one-quarter trillion dollars in revenue and sell more than one-quarter billion iPhone handsets. In the upcoming December quarter the company will set yet another record for corporate profitability in a three-month period.”

I posted the above paragraph as a comment on a recent column by Philip Elmer-DeWitt about Apple’s upcoming September 9th event. The focus of Philip’s column, in my interpretation, is the incessant demands of Wall Street for sensational new products, “one more thing” surprises and almost Hollywood-style showmanship at every Apple special event. I concluded my comment by posting, “While some on Wall Street might want the likes of PT Barnum, most of us who buy Apple products and invest in the company’s stock prefer the steady hand of CEO Tim Cook.”

While millions of us may enjoy discussing, debating and speculating about what new products Apple might have under development or may announce during the company’s fairly regular product events, the company’s revenue over the past several years has been marked by an impressive and unbroken sequence of rising year-over-year quarterly growth. This has occurred without game show-style product introductions or fantastical claims about future product features and functionality. 

Apple And The Long Arc Of Time 
The graph below illustrates Apple’s revenue on a quarterly basis as far back as FQ1 2009. In that quarter recognized revenue was $11.880 billon. By comparison, in FQ1 2015 Apple’s recognized revenue was $74.599 billion or a greater than six-fold increase in revenue in the first quarter of the fiscal year over a six-year period of time. No wonder Apple’s CEO is fond of the term “long arc of time” when responding to analyst questions during the quarterly conference call with analysts. When Apple completes the current fiscal year near the end of September, the company will report a greater than five-fold increase in revenue over the same six-year period. 
The corresponding EPS graph below illustrates an even more impressive outcome during this six-year period. Again using FQ1 2009 as the benchmark, Apple’s earnings per share in FQ1 2015 of $3.06 was 8.5 times greater than the split-adjusted $.36 in eps reported in FQ1 2009. While the company’s ongoing share repurchase program has diminished the fully diluted share used on a split-adjusted basis in this comparison, the company’s rising revenue has been the most substantial factor in the eps growth rate.

The Street’s Consensus Estimates
Although Apple continues to deliver quarterly revenue growth on a year-over-year basis, the Street maintains a very cautious outlook for the fiscal year beginning in late September. As of this writing, The Street’s consensus revenue estimate for FY2016 is, according to Yahoo! Finance, $244.66 billion or an anticipated revenue growth rate of 4.90%. The Street’s consensus eps estimate at this time for FY2016 is $9.78 or an anticipated eps growth rate of 7.12%.

Over the first nine months of the current fiscal year, Apple’s revenue has risen about 30% led by a very impressive 41% rise in iPhone handset sales. While I don’t anticipate a repeat of Apple’s current revenue growth rate next fiscal year, I am anticipating revenue of $275 billion or revenue growth in the range of 17%.

The Revenue Performance Of The iPhone And iPad Product Lines
For this example I am purposely combining the revenue of the iPhone and iPad lines to illustrate the continuing success of Apple’s iOS-based mobile device platform. In FQ1 2015 and despite the falloff in iPad sales, the two product lines represented just over 80% of reported revenue. In the first nine months of the current fiscal year, the concentration of revenue remained over 70% in each of the three quarters.

The iPad line’s year-over-year unit sales decline began in FQ3 2013. I expect the line’s unit sales to stabilize on a year-over-year basis next fiscal year. This isn’t wishful thinking. According to Luca Maestri, Apple's CFO, the iPad has gained traction in the enterprise market and holds 75% US marketshare for tablets costing $200 or more.The iPad line will benefit from IBM’s MobileFirst for IOS program. 

While I do expect a moderation of the iPhone line’s current unit sales growth rate next fiscal year, I expect unit sales growth to remain solidly in double digits throughout FY2016. Over the long arc of time Apple's concentration of revenue in the iPhone and iPad lines will gradually diminish. However, since the introduction of the iPhone in 2007, there has yet to be a fiscal year in which the rate of unit sales growth fell to single digits. Even at 10% unit sales growth in FY2016, revenue from the iPhone line alone would push aggregate revenue above the Street’s current revenue consensus estimate for the fiscal year.

Apple’s Services and Other Products
The graph below illustrates the performance of Apple’s Services and Other Products revenue segments since FQ1 2012. Over this multi-year period the decline in iPod unit sales put a damper on the performance of the Other Products revenue segment. In FQ3 2015, the first quarter to reflect Apple Watch revenue activity, the segment delivered over $2.5 billion in revenue for the first time outside of a holiday quarter. In the first six months of the coming fiscal year, all Apple Watch revenue will be accretive to the company’s revenue growth. Also in FQ3 2015, Services revenue broke through $5 billion for the first time.
Apple’s Revenue and EPS Growth Rates
The graph below illustrates Apple’s revenue and earnings per share growth rates since FQ1 2010. As Apple’s $140 billion share repurchase program kicked into high gear, the rate of eps growth began to again exceed the rate of growth in revenue. Since FQ2 2014, Apple’s eps growth rate has exceeded the rate of revenue growth in every quarter.
Through the ongoing share repurchase plan, Apple’s has already reduced the fully diluted share count by over 13% from the high point in FQ4 2012. With $50 billion remaining in repurchases to be made as of June 27, 2015, Apple will continue to bring down the fully diluted share count through the end of the current repurchase program in FQ2 2017.

Following a five-quarter cycle of single-digit revenue growth, Apple returned to double-digit revenue growth on a year-over-year basis in FQ4 2014. With the expected release of new iPhones and iPad this fall and the revenue contribution from the Apple Watch line, I expect double-digit revenue growth to continue throughout FY2016.

Apple’s Gross Margin Per Quarter
The graph below illustrates Apple’s gross margin on a quarterly basis since FQ1 2010. Since FQ2 2014 Apple’s gross margin has not fallen below 38%. As the company enters FY2016, management will be riding down the cost curve on the iPhone 6 series handsets. Although some foreign exchange-related pressures may continue into the first half of the new fiscal year, I expect gross margin outcomes to remain favorable for the company.
Apple’s FY2016 Performance
In August of last year the Street’s consensus revenue estimate for FY2015 was $197 billion. Apple will end the current fiscal year with revenue in the range of $235 billion. I consider the Street’s consensus revenue and eps estimates for FY2016 at this point in time to also be quite conservative. 

Rising revenue, strong gross margin and the ongoing reduction in the fully diluted share count will combine to deliver a fiscal year performance well above the current Street expectations. Double-digit iPhone unit sales growth, continued Mac unit sales growth at least in the high single digits and revenue from the new Apple Watch line will all contribute to an impressive FY2016 performance for the company. This does not include the revenue benefit of any new products or services that will be announced on September 9th.

Apple’s September 9th Event And Beyond
As I mentioned earlier, we all enjoy speculating about what new products Apple will release in the future and how the company will enhance, even in incremental ways, the features and functionality of its existing product lines. There’s certainly nothing wrong with being fascinated by the advances in technology Apple brings to market.

However, the company’s long-term success is not based on any one event or even one product line. Apple is an enterprise constantly in transition. Similar to the each of the company’s quarterly reports, any one product event represents only a static snapshot in time of a fast-moving enterprise object. 

It’s not the September 9th event that will make or break the company’s success next fiscal year. In my view, any new products or services announced will only add to the company’s ongoing success. I intend to be among the first buyers of the much-anticipated new Apple TV and it’s time to replace my iPhone 5s handset. I look forward to seeing what Apple announces in less than two weeks. 

But over time, it’s the long arc of time that demonstrates the magnitude of the company’s success. 

Robert Paul Leitao

Disclosure: The author is long Apple shares