Apple’s second fiscal quarter has just ended. Time for analysts to put forward their predictions for the quarter’s report (due in about 3 weeks.) If history is a guide, the estimates will range quite widely and accuracy will be determined mostly by the ability of an analyst to predict iOS device sales (and iPhone most of all).
How hard can it be?
Since reporting on the 18th, I’ve mostly finished going over the the fourth quarter Apple data. Here is a quick summary of the articles that covered the financial and product performance:
That leaves one more: Summary view of cash flows.
As the highly profitable iPhone makes up an increasingly larger proportion of Apple’s sales, the overall gross margin would be expected to grow.
Sure enough that’s what’s been happening.
The gross margin percent, which measures the direct or variable costs of production vs. price, shows a healthy rise in the last five years from slightly below 30% to around 40%. The Operating Margin, which also includes the overhead or fixed costs like R&D and SG&A, shows a similar rise, reaching about 30%.
Margin expansion while sales quadruple is a good indicator that a company is producing real value not just trading sales volume for profit.
In a recent but recurring lament I asked why Apple shareholders are not being rewarded for the company’s growth. I pointed out that there is no fundamental reason why the company should receive such a low P/E multiple (about 18 ex-cash trailing and 10x forward while maintaining 70% earnings growth for over a year).
There were many objections in the comments. Most of them dealt with recent reasons why doubts might have arisen among investors: Android hegemony or some perceived lack of competitiveness leading to margin compression or some macro hangover from the recession.
In this article I argue that none of these objections hold water. My argument hinges on the fact that there is a precise date when Apple ceased being seen as an exceptionally valuable company and that date precedes any of the causes being suggested.
The day of disillusionment was almost exactly three years ago: January 14th, 2008.
In the previous article discussing the growth scorecard, I left open the question of how Apple’s growth is reflected in its share price.
The approach to answering this question is to show how the share price correlates to that growth. The challenge for analysts has been that the company switched from subscription to current accounting for the iPhone (the largest component in its income statement). As they re-stated income and thus earnings, any historic review of P/E or other multiples of Earnings have to also be re-computed.
So this is what I’ve done:
Every quarter I try to score growth by top, bottom and product lines. As unforeseen growth is the only driver creating shareholder value, it’s of paramount importance to measuring a company’s performance.
For Apple, the analysis is fairly straight-forward. There are relatively few product lines (seven including the iPad). I measure y/y sales growth and try to form a picture that is easy on the eyes and mind.
The method I’m using now is color coding growth for each line according to the legend to the left.
The table that follows shows each product plus the Net Sales and Earnings lines according to this color coding. I also added an average column for reference.
After the last earnings report, many noted that Apple’s gross margins dipped. Turley Muller noted in a letter to PED that the cause was probably the aggressive ramp in iPhone 4 production which broke new records at 14.1 million units.
That may be. My estimate of iPhone margin shows it dropping to about 49% from the more usual 55% (sometimes even higher). We’ll never know exactly how much, but sometimes margins drop. RIM and Nokia are punished for drops in the GM percent so why shouldn’t Apple?
However, there are some other factors to consider: the overall margin is currently historically very high. As the high-margin iPhone makes up more of the total product mix, the overall margin should be growing. And it is. The chart below shows the trend since 2005. GM was in the high 20′s five years ago.
Note however the other margin: operating margin. After taking the fixed costs into consideration (which we saw to be shrinking as a percent of sales), Apple’s bottom line profitability has been rising slightly more rapidly than the GM. It has plateaued recently but not dipped significantly.
Also note that there have been dips in the past from which GM expansion resumed. One such dip was at the launch of the first iPhone in 2007, though we can’t be sure that was attributed to the iPhone itself or to other factors like that most cited by management: components costs.
However, the bottom line profitability is only part of the picture. It would be instructive to look at which product contribute how much. You won’t see this analysis often because the gross margin by product is not published by Apple and it takes quite a bit of guesswork to get there.
I maintain product-level gross margins and compute the overall GM bottom-up. The product-by-product line profitability is based on several assumptions which I won’t detail here, but those assumptions lead to the following contribution chart:
Oppenheimer on the concall:
We expect revenue to be about $23 billion compared to $15.7 billion in the December quarter last year. We expect gross margins to be about 36%. We expect OpEx to be about $2.325 billion.
We expect OI&E to be about $65 million. And we expect the tax rate to be about 25.5%. We’re targeting EPS of about $4.80.
Here are my expectations:
During the last quarter the company added $5.2 billion to its cash, long- and short-term marketable securities accounts for a total of $51 billion. This amounts to about $53 per share vs. $49.43 per share in July (making the share price about $250 ex-cash).
I would caution again that when reading commentary about Apple’s cash that many observers exclude long-term securities from the “cash” total.
To see the difference in the total, this chart breaks out the three different accounts over time.
We expect revenue to be about $18 billion compared to $12.2 billion in the September quarter last year. We expect gross margins to be about 35%…
We are targeting EPS of about $3.44.
via Apple Inc. AAPL Q3 2010 Earnings Call Transcript.
I’ve updated my estimates from the July forecast as follows: