Apple's Good Problems 11 comments
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When Steve Jobs came on Apple's (AAPL) conference call the last go-round, it was designed to put analysts and investors at ease. That it did; his presence calmed questioning and glossed over a then shockingly broad and conservative forecast for the holidays: earnings of between $1.05 and the $1.30s per share of Cupertino fruit.
Introducing the Non-GAAP method for earnings was equally brilliant and needed, as analysts couldn't shake their traditional valuation methods of the company. The curve ball thrown by the iPhone's subscription accounting led to steady devaluation of the company stock, which then was taken brutally by the whirlwind of economic turmoil alongside the market. Bullish Cross (Link) did some of the most notable work recreating Apple's earnings for FY2008 putting "actual" earnings at around $7.50 vs the $5.36 reported in the standard GAAP way. A difference of over $2/share in earnings and about $40/share in price at a P/E of 20.
However, this subscription method which undervalued the company tremendously during the early stages of the Bears will help propel the company forward in the troublesome economics that exist today. Steve's worker zealots could completely take the holiday months off and still count 1/8th of a year and half of the incredible selling iPhone revenues and earnings. But Apple folk aren't taking any time off and the expanding retail chain will be busier than ever this Christmas. Unfortunately it appears some of the company estimators forgot two important facts when placing Christmas build orders:
1) Apple products are hotter than ever, and
2) People buy iPods as gifts no matter what
According to some work by long-time Apple researcher Shaw Wu, Apple's experiencing wide shortages on iPods of all shapes and sizes. While analyst work can fall into several quality categories (most notably the work done by Gene Munster is always carefully calculated), checking shipping lead times on several web sites just doesn't qualify as ground-breaking research. It does however provide a simple barometer for demand if the sites you're checking happen to be some of the biggest in America (Sites like Amazon.com, Best Buy and Wal-Mart). As an aside, Wu has been a constant on the Apple analyst, providing reports to clients almost constantly.
When these retailers are showing shortages of select colour/storage combinations and long shipping times of other models, it does qualify as cause for concern. Did Apple ship pessimistically along the lines of its forecast? Did it simply underestimate strong demand for its ubiquitous music players?
I believe the answer lies somewhere in the middle. Apple is being incredibly prudent in its cost controls these days, and after revealing to the world its new line-up of MacBook and MacBook Pro laptops and their new all-aluminum design process, the R&D costs are aplenty. Couple this with the on-going work on the next version of its operating system OS X Snow Leopard (which is expected in early-mid 2009), iPhone/iPod Touch continuous software updates and whatever surprises are in store for MacWorld 2009 in January. Some cost prudence is almost a necessity.
The company may have overshot it, though, in assuming current economic conditions would make the $230-$400 iPod Touch a tough sell. The reality is that the "Funnest iPod Ever" is performing exceptionally well and there are several reasons for it. Apple's online store has plenty of stock and has the Touch as a top seller. The App Store however, is near the top of the list if not at the peak of reasons to get the Touch. The Software marketplace is pushed heavily by the iPhone in all adverts, is also on and available for all iPod Touch devices, and makes the device far more than an iPod. As for the other models, iPod Nanos and Shuffles continue to make a great stocking stuffer year after year.
Amazon.com's list of top selling MP3 players is dominated by Apple, currently holding the top 10 spots, and 15 of the top 16. Dominance like this is incredibly hard to achieve, and even harder to maintain, as Apple has now done for the last several years. So with that research in hand, Wu's estimates call for 21Million iPod units to be sold, a little short of last year's record of over 22Million, but nonetheless a very successful holiday given current economics. Given the premise of over 20Million iPods, driven primarily by iPod Nano and iPod Touch devices, the logical thing for analysts to do would be to project a very healthy stream of iPod related revenue and earnings in the quarter.
Analyst conclusions on iPhone sales also represent the type of growth the company saw in the early years of the iPod rise. Last year's 2Million+ unit number is expected to nearly triple through the combination of in-store activations and iPhone-specific gift cards. Corresponding AppStore sales will also be ready to incline in step, thus it's safe to say the phone division is on solid ground for 2009. If China ever gets works out, the addressable iPhone market could potentially growth by another 600Million users.
So, all that's left for Apple to do is to prove the new Mac portables are as popular as they've started out being and you've got a company that will spend another conference call giving each other "corporate-speak" high fives, trying to step around typical analyst questions on how Apple bucked all these devastating economic head-winds. Last year's earnings of $1.76/share seemed so far away during the conference call and its accompanying guidance. With these latest analyst report, there is plenty of room for the consensus estimate to move higher.
The Vegas Line stands at $1.46 and I expect it to move to the 1.50-1.60 range as Jolly Saint Nick nears.
Disclosure: Author is long AAPL
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This article has 11 comments:
The great Republican Recession is really just getting started - in spite of the fact that we have now officially been in it a year. Housing market shows no signs of improving, and we are just in the beginning of the job loss cycle. It seems that most economists are saying that we will be in recession at very least into 2010, and possible even longer. Unemployment will surely reach 9% and quite possibly well over 10%.
So the question is - Will even Apple be immune to falling sales once the job loss really hits? Of course they will weather the storm in much better shape than anyone else with their huge cash reserves. Still, I think there will be rough times even for Apple in the coming years.
IMHO
What you call 'company estimators' are actually made up, in most companies (Apple is probably no different) of a group that consists of forecasting, demand planning, master scheduling, and production planning. Each group has a distinct role in ensure that demand roughly equals supply. That's just a business detail of how stuff gets planned and produced.
Now, about the major point, Apple does have a (I'll use finger quotes here) 'problem' with its holiday inventory this year. Demand exceeds supply across many retailers and there are many articles mentioning wait times of 2-4 weeks. Did Apple screw up? What to do?
In my opinion, Apple has played this exactly the right way for a number of reasons.
First, they set expectations by casting a broad and low earnings per share figure for their Q1'09. Nice start. Companies like RIM continually try to pump up their stock price through aggressive earnings forecasts and look at RIMM now. Apple underpromises and overdelivers because they don't care about their stock price except for the long-term. They are the model for how a publicly-traded company should behave.
Second, what's hotter for the market - stuff you can't get, or piles of inventory? Exactly. Now, every parent is right where we want them. And, if you assume that 90%+ of holiday demand goes to Christmas gifts (as opposed to other December holidays) there is nearly a month between Black Friday and Christmas. Not much time to get more inventory, but perhaps enough.
Third, Asian component manufacturers and production facilities are not exactly going gangbusters right now. For the first time in a decade or more, many have completely idle capacity. Which means, if Apple intended to use Black Friday as a demand gauge (putting about 85% of expected stock in place), they could use the intervening 4 weeks to deliver stock serving the marginal demand between then and Christmas. They should then have ample time to get more stuff to market.
But only if they follow the fourth point....every company can choose to expedite shipments from manufacturing locations if they need supplies urgently. Most items at Best Buy are shipped via ocean container, but using the cheapest form of shipping gives the manufacturers of low margin desktop computers and $49 DVD players no ability to respond to demand swings. This is where Apple's premium pricing helps operational decisions - those pallets of iPod Touches will not be sitting in a freight container today - they will undoubtedly be loaded into a nice 747 cargo bay for receipt at SFO 12 hours later.
And, in summary, here's the best part - the brand image - including scarcity - is preserved, there is no '35% off' inventory sitting around on December 26th, and parents are almost sure to be happy. Just watch.
Just think about how much production, packaging, palletizing, shipping, receiving, putaway, pick, delivery, receipt, and stocking cut into profits for typical game manufacturer.
Apple is right again.
Good observation!
How "democratic" too, for software developers, not having to compete for floorspace or product positioning on a shelf of software, or risk the outlay of funds for physical production of CDs, packaging, and shipping.
Would ANY of that have happened for some of the "cute" addictive games , like "Word Freak" that we just download from iTMS?? No.
I want to mention the ELEGANCE of how well the product lineup integrates with your home computer. Firmware updates on iPhones and iPods are super easy, and they all work alike, with the same program. When iPhone was introduced, 100 million people ALREADY had the necessary program installed with libraries of tunes and videos just waiting to sync! how nice.
Also, the assemby of iPhones and Touch iPods looks VERY simple. AND most of the parts are interchangable! So if iPhone sales go down, they could use the parts for iPod Touches, and vise versa.
Perhaps Amazon, Best Buy and Walmart are the ones who underestimated demand...
On Dec 05 05:48 AM howmany wrote:
> Many have missed how the existing world of iPod owners do realize
> how different the Touch is, and many are making the upgrade. From
> this perspective we may see units sales drop slightly, but the mix
> will include more of the high margin device. Revenue will therefore
> not drop in proportion to the unit drop. I just hope Touch shortages
> are shortlived as you don't get a lot of second chances with holiday
> shopping.
Now, regarding Apple, they probably don't have a ton of extra inventory sitting around, given that they serve $32.7 billion of revenue annually with the remarkably low inventory value of $509 million at the end of last quarter. They have had past issues with high inventory, but their focus on operational improvements since Jobs returned have probably focused on the root cause of high inventories in tech; namely, inflexible manufacturing schedules, lengthy production cycle times, and long lead times for ocean shipment. A resulting consequence of this is that they can do more with less inventory than any other tech company, and they write off no unsold inventory.
The best unintended consequence for Apple - backorders at retailers drive customers to buy direct from Apple online or through the Apple Store. Either way, they receive full margin. Therefore, look for their Q1'09 margins to be significantly higher than guidance.
I have never, ever seen a company so completely well thought out. It all fits together. It's a pity it isn't currently appreciated via stock valuation in this economic climate, but I am confident that they will emerge in the strongest possible position.