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. 

Spaceship Apple Comes Down To Earth

Apple's September results were below most expectations. The $28.27 billion in revenue represented a $300 million sequential decline and a comparatively languid 39% year-over-year gain. On earnings per share, the 52% year-over-year rise to $7.05 was far below the 96.2% rate of eps growth realized over the first nine months of the fiscal year.

The Good News In The September Quarter

Mac Unit Sales: If there's good news to be found in the September quarter results it's the 26% growth in Mac unit sales against a global PC market with diminished prospects for continuing growth. In addition to strong unit sales growth, revenue from Mac sales rose 29%. 

Asia-Pacific: The Asia-Pacific region (exclusive of Japan) turned in a 139% increase in revenue. Although the September quarter's pace of revenue growth was below the rates of growth in the region realized in the previous two fiscal quarters (down from 247% growth in the June quarter), China is Apple's most important growth market at this point in time. Asia-Pacific's $6.53 billion revenue contribution represented 23.1% of Apple's total revenue in the period.

Apple's December Quarter Guidance: Management has guided to revenue of $37 billion or 38.4% revenue growth and eps of $9.30 or growth of 44.6% over the December quarter one year before. But keep in mind December quarter 2011 (FQ1 2012) includes an additional shipping week that occurs once ever six years to better align fiscal quarters with calendar quarters. The unusual 14th week is the week immediately after Christmas. Absent the additional shipping week, guidance would have been more conservative and it moves a high revenue week away from the following quarter. 

The Not-So-Good News In The September Quarter

Retail Stores: Despite a 25% increase in Mac unit sales at the stores in the September quarter and the first fiscal quarter in which the retail stores sold over 1 million Macs, overall store revenue rose only 1%. Apple ended the quarter with 357 stores open for business and new stores were opened in the fiscal period. This 1% revenue rise includes the revenue activity of new stores opened within the past year. Retail store traffic and revenue growth remain heavily influenced by seasonal factors and Apple product refresh cycles. 

iPhone Sales: Management stated during the conference call with analysts that September unit sales were materially impacted by a drop-off in demand ahead of the release of  the new iPhone 4S handset. iPhone unit sales growth remains heavily dependent on the company's product refresh cycle. The 16% sequential drop in unit sales is in light of surging global smartphone demand and the meager 21% year-over-year gain in unit sales is against a prior-year period in which Apple ended the quarter with constrained supplies of the then latest handset. Although Apple reported outsized unit sales growth for the iPhone of 142% in the June quarter, both Asia-Pacific and the Verizon agreement were big factors in that gain. 

The AFB AAPL FQ3 Estimate Index

The Apple Finance Board (AFB) is home to many AAPL traders, investors and Apple product enthusiasts. Among the members of the AFB are well know independent analysts Daniel Tello (deagol), Horace Dediu (aysmco), Turley Muller and Andy Zaky. I serve as the moderator of the AFB under the DawnTreader moniker. 

AFB AAPL FQ3 Estimates

Each fiscal quarter active members of the AFB are polled for their estimates of Apple's quarterly performance based on product unit sales and financial outcome. This article highlights the anticipated financial outcome for the three-month period ended in late June (Apple's FQ3 2011). Tomorrow I will post the unit sales estimates from each index participant by product line that underpin these financial performance estimates. 

On average the 30 active AFB members participating in the June quarter index estimate Apple will report the following results for the company's third fiscal quarter:

AFB Member AAPL FQ3 Estimate Averages:

Revenue			$26,556	69.14%	(% YOY Revenue Growth)
Gross Margin			10,714	40.35%	(% of Reported Revenue)
Operating Expenses			2,542	9.57%	(% of Reported Revenue)
Pre-Tax Income			8,235	31.01%	(% of Reported Revenue)
Tax Expense			1,987	24.12%	(% of Pre-Tax Income)
Net Income			6,248	23.53%	(% of Reported Revenue)
EPS			6.66	89.61%	(% YOY EPS Growth)

All numbers in thousands except per share data.

During the first six months of the current fiscal year Apple's revenue rose 76.2% and eps rose 83.2% in year-over-year comparisons. As a group AFB members estimate the pace of revenue growth in the June quarter will have slowed slightly to 69.14%. However, the pace of eps growth is estimated to rise above the performance of the first six months of the current fiscal year to 89.61%.

Factors Impacting the June Quarter Financial Performance

The June quarter represents the first fiscal quarter in which Apple iPad sales are a factor in the prior-year performance. This factor alone will will have an impact on year-over-year revenue growth. iPad unit sales and the resulting revenue were not a factor in the prior-year financial performance comparisons in the December (FQ1) and March (FQ2) quarters.

Apple has effectively managed the growth in operating expenses relative to revenue growth. The company's ability to keep this major expense segment under 10% of reported revenue and the rate of growth of operating expenses well below the rate of growth of revenue is having a significant and positive impact on the company's earnings per share performance. AFB members are estimating the percentage of revenue that flows to the net income line will reach above 23.5%.

Robert Paul Leitao

Disclosure: The author is long AAPL shares

Why I'm Bullish on Apple

Over the past several weeks I've focused much of my analysis work on the performance elements that underpin Apple's extraordinary rates of revenue and earnings growth. Meanwhile, Apple's share price (AAPL) has been trapped in a comparatively narrow and underwhelming trading range since the all-time high of $364.90 was set in intraday activity on February 16th of this year.  

There's much speculation why Apple is currently trading, even after today's strong advance, almost 5% off the all time high at Tuesday's closing price of $347.83 per share. From index rebalancing to hedge fund ploys, most active AAPL traders have their own views as to the factors impacting the share price. But none of these factors in any way impact the company's fundamental strengths nor limit the long-term potential of the share price. I consider AAPL's current trading price to represent a short-term dip below an established trading range prior to a strong, bullish advance. 

The Factors Supporting AAPL Share Price Appreciation

Rising Revenue, Rising Earnings Per Share: Apple remains in an era of extraordinary revenue and earnings growth. During the first six months of FY 2011 Apple's revenue and earnings growth rates have accelerated due to the popularity of the Apple iPad and the continuing success of the Apple iPhone. In the first six months of FY 2011 Apple's revenue rose 76.2% and eps moved higher by 83.2%. Constraints on iPad 2 supplies in the March quarter limited the revenue and earnings growth rate from moving even higher. 

For FY2011 (ending in late September) I forecast Apple's revenue will reach or exceed $112 billion and eps will reach at least $27.50 per share. Based on my forecasts Apple is currently trading at a multiple of only 12.65 times the current fiscal year eps estimate. The revenue growth chart, including my FY 2011 revenue estimate, illustrates the pace of Apple's revenue growth over a six-year period. Over 60% of Apple's revenue in FY 2011 will be sourced from products that did not exist in the marketplace as recently as four years ago today. The markets for the Apple iPhone and especially the Apple iPad have yet to be fully realized and the markets for both products will continue to expand. 

Even more dramatic than the pace of revenue growth is the pace of growth in earnings per share. Form eps of $1.55 in FY 2005 to estimated eps of $27.50 in FY 2011.

FY 2012 Analyst Estimates: Why AAPL Is Set To Pop

On September 11, 2010 I published a post titled FY2011 Analyst Estimates: Why AAPL Is Set To Pop. At the time the post was published AAPL had ended the week's trading at $263.41. Seven months later and with AAPL closing on Friday at $335.06, the share price is poised to again move higher and more than surpass the all-time trading high of $364.90 set on February 16, 2011.

Analyst FY 2011 Estimates

At Friday's closing price of $335.06 and a price-earnings multiple of 18.69 times trailing 12-month earnings per share, AAPL is trading at a deep discount to the company's 67% rate of eps growth in FY 2010 and the December quarter's eps growth rate of 75.2%. The current Wall Street consensus for the March quarter is revenue of $23.18 billion and eps of $5.33 per share or an eps growth rate of 60%. For FY 2011, ending in September, analysts are expecting revenue of $100.43 billion or about 54% revenue growth and eps of $22.97 or  eps growth of about 51.2%. Both estimates are well below current rates of growth. In the December quarter revenue rose 70.5% and eps 75.2%. But the disconnect between the analyst consensus and the company's current rates of growth become even more dramatic for fiscal year 2012 that begins in late September. 

FY 2012 Analyst Estimates

Expanding on a comment I made on a recent Apple 2.0 column titled AAPL: What Could Go Wrong?, the Street FY 2012 estimates for AAPL deny reality. The current Wall Street analyst consensus for FY 2012 is revenue of $117.95 billion and eps of $26.51. It's possible (and increasingly probable) Apple will meet or exceed those average estimates this fiscal year. In other words, the Street is forecasting zero revenue and earnings growth for next fiscal year. If Apple's December quarter rates of revenue and eps growth remain consistent, the company will report revenue of $111.20 billion and eps of $26.54 this fiscal year. For the March quarter I estimate revenue growth of  87% and eps growth of just under 90%. For the fiscal year I expect earnings per share of no less than $27. 

To reach the Street's current FY 2012 revenue consensus in FY 2011 revenue would need to rise this fiscal year by about 81%. To reach the FY 2012 eps consensus in FY 2011, eps would need to rise this fiscal year about 75% or about the same rate of eps growth reported in the December quarter.

Apple's Dynamic Revenue Mix

To sustain strong revenue and eps growth over the next eighteen months and through FY 2012, Apple does not need to release additional new products. In the recent December quarter (and according to my estimates again in the March quarter), iPhone revenue growth exceeded total revenue from iPad sales activity. The company's existing product lines (now including the Apple iPad) already provide a strong foundation for revenue and earnings growth for at least the next eighteen months. 

iPad revenue will surpass the revenue generated from Macintosh unit sales in the current June quarter, positioning the iPad as Apple's second highest revenue generator behind only the iPhone. The expanded domestic iPhone distribution that now includes Verizon network subscribers and the expected expansion of iPhone distribution in China sometime prior to the start of FY 2012 will sustain high rates of iPhone unit sales growth through the next fiscal year. The global market for the Apple iPad is in its early stages of development and iPad unit sales growth will also support strong revenue growth for the next several quarters. These factors alone suggest FY 2012 revenue of at least $165 billion and eps of at least $40, well above current Wall Street analyst estimates.

Apple: Nine Quarters of Results

Apple: Nine Quarters of Results
As a service to AFB members and my fellow AAPL analysts, I'm posting Apple's results for the nine most recent quarters. This post is without commentary and is to serve as a resource and reference for readers who are actively tracking the company's quarterly results.

I will be referencing this post in future Posts At Eventide entries and will be using this data in compiling my own Apple quarterly estimates and AAPL share price forecasts. The quarterly results for FY2009 are post-retrospective adjustments for the change in accounting principles applied to iPhone revenue recognition.

Robert Paul Leitao

	FQ1 2011	FQ4 2010	FQ3 2010	FQ2 2010	FQ1 2010	FQ4 2009	FQ3 2009	FQ2 2009	FQ1 2009
Net sales	26,741	20,342	15,700	13,499	15,683	12,207	9,734	9,084	11,880
Cost of sales	-16,443	-12,831	-9,564	-7,874	-9,272	-7,102	-5,751	-5,457	-7,373
Gross margin	10,298	7,511	6,136	5,625	6,411	5,105	3,983	3,627	4,507
Operating expenses:
Research and development	575	494	464	426	398	358	341	319	315
Selling, general and administrative	1,896	1,571	1,438	1,220	1,288	1,063	1,010	985	1,091
Total operating expenses	-2,471	-2,065	-1,902	-1,646	-1,686	-1,421	-1,351	-1,304	-1,406
Operating income	7,827	5,446	4,234	3,979	4,725	3,684	2,632	2,323	3,101
Other income and expense	136	14	58	50	33	45	60	63	158
Income before provision for income taxes	7,963	5,460	4,292	4,029	4,758	3,729	2,692	2,386	3,259
Provision for income taxes	-1,959	-1,153	-1,039	-955	-1,380	-1,197	-864	-766	-1,004
Net income	6,004	4,307	3,253	3,074	3,378	2,532	1,828	1,620	2,255
Earnings per common share:
Basic	$6.53	$4.71	$3.57	$3.39	$3.74	$2.82	$2.05	$1.82	$2.54
Diluted	$6.43	$4.64	$3.51	$3.33	$3.67	$2.77	$2.01	$1.79	$2.50
Shares used in computing earnings per share:
Basic	919,294	914,555	912,197	907,548	903,542	898,032	893,712	891,180	889,142
Diluted	933,154	928,825	927,361	922,878	919,783	914,374	909,160	902,993	901,494