The bears have been in control of Apple since the correction began on September 21st. If their reign is to continue, it's going to occur because of Apple's deteriorating fundamentals because the institutional/fiscal cliff re-balancing that was caused by Apple's strength (74.5% YTD gains as of September 21st) is now over. We're seeing a healthy dose of uncertainty ahead of the January 23rd earnings report in large part because Apple missed earnings estimates last quarter. Aside from the noise of these pre-earnings jitters, the real question is ... how do the fundamentals look?
In 2009 I wrote a piece titled Apple: Seven Reasons the Shorts Love It that explained a few of the reasons behind Apple's slingshot action. The content of that article is especially pertinent when Apple is near the high end of its trading range. Today, from an opposite point of view, I'm tweaking the title to 'Apple: Seven Reasons Shorts Can't Sleep at Night'. This content is especially pertinent with Apple near the bottom end of its trading range. Apple investors know what keeps us up at night, but what about an Apple bear? What keeps them up at night? Consider the following variables:
1- The trading range. As part of its range bound behavior, AAPL has shown no appetite to drop below $500. This stabilization has led to a bottoming process that began when Apple hit $505 on November 16th. As bad as December's capital gains selling was, it was unable to produce lower lows. Throughout December and early January the range of stability has remained constant between $519 and $532. Pre-earnings jitters have resulted in another effort to crack $500 on the news of iPhone 5 supply chain cuts (Which is old and irrelevant news by the way. Apple had build plans for 60 million iPhones in the March quarter. Of course actual supply was going to be cut towards 40 million units) but from the point of view of an Apple bear, the risk/reward window between $500 and the prior high of $705 is concerning when we consider the stock is currently priced at $500. With bears in charge, it would be nice to see more downside momentum. Over the past five years, Apple's success rate in bouncing to new highs after $100 corrections is 100%.
2- The idea that Android is taking over the world is completely false. Through mid December the iPhone 5 could not be kept on shelves. Buyers were forced to either order online or arrive early at an Apple store before the daily allotment was sold out. This intense demand hasn't been limited to iPhone, similar frenzies are occurring for those wanting an iPad mini or a new iMac. Android hasn't been able to put a dent in Apple's profit machine. A recent report released by Kantar ComTech revealed that Android market share declined 10.9% to 41.9% while Apple's iOS market share reached 53.3% in the 12-week period ended November 25th. It appears that Android's real strength is as a cheap alternative to the iPhone. Samsung (SSNLF.PK) bombarded the market with 37 different models in 2012, HTC (HTCCY.OB) came out with 18 models, LG (LG) had 24 and Nokia (NOK) released 9. Samsung's flagship smartphone, the Galaxy S III, sold approximately 15 million units in the holiday quarter compared to approximately 50 million iPhone units. In the midst of this tech revolution, the only way for Apple to fail is to have a competitor rise up. Beyond smartphones, tablets are even worse for Android. According to Chitika Insights, the iPad commands 87% of tablet web traffic in the U.S. and Canada as of December 27th. Android is showing no ability to cut into Apple's profit growth trend. There may be months when Android market share shows gains over iOS but those market share gains have yet to translate into profit share gains.
3- Apple CFO Peter Oppenheimer's lowball guidance worked. In the October earnings call Oppenheimer announced that Apple's holiday quarter guidance was for EPS of $11.75 which represents a year over year decline of 15.28%. Before Oppenheimer's guidance, the analysts were forecasting holiday quarter EPS of $15.44. In response to Oppenheimer, Wall Street expectations have declined to EPS expectations of $13.33. Expecting a year over year decline in EPS (last year was $13.87) is a favorable scenario for Apple investors. Oppenheimer got what he wanted.
According to the research of Robert Paul Leitao, Apple's guidance tends to be closer to actual results in the waning quarters of each iPhone model year whereas actual rates of revenue growth tend to handily surpass management guidance in the quarters immediately following a new iPhone release. Actual EPS has averaged 30% higher than guidance in the first two quarters following an iPhone handset refresh.
Even more bullish is Jefferies analyst Peter Misek. All you need to know about Misek is that he should change his name to Mr. iPhone. This guy can be hit or miss regarding the accuracy of new product predictions like Apple TV but his iPhone forecasts are as good as any. He was the analyst responsible for alerting the street to the reality of an iPhone 4S rather than the iPhone 5, it was his December report from Asia that alerted investors to Apple's plan of offering multi-colored iPhones in the summer of 2013, and he also was near the lowest of analyst estimates for iPhone sales last quarter when Apple missed consensus. Apple didn't miss Misek's number, he predicted sales of 26 million units and actual sales came in at 26.9 million. Misek is a well educated analyst who understands what it means to under-hype so that Apple can be judged fairly.
With consensus expecting 47.6 million iPhone units for the holiday quarter, Misek is reporting from his latest trip to Asia that Apple executed on its plan to build 60 million units. His official quarterly forecast is for sales of 53 million. Anything above 50 million will cause a Wall Street frenzy. With Apple ramped for the Chinese New Year we expect Q1 2013 to perform well. His iPad number is at 24 million for the holiday quarter. If Misek's projections are close to actual results, we're looking at 43% iPhone growth and 55% iPad growth which will result in EPS that is even higher than the original analyst estimates of $15.44 that we saw 90 days ago.
This kind of massive beat is not unprecedented. It happened last year when Apple guided for EPS of $9.30 in the 2011 holiday quarter and actual results came in at $13.87 (49% beat) which spurred an almost $300 stock recovery. If EPS comes in at $15.50 (32% beat over management guidance ... consistent with Leitau's precedent) it will crush the bears. A 49% beat of EPS at $17.50 is not out of the question if the concerns of margin pressure due to new product launches, currency fluctuations, and unfavorable component pricing prove to be unwarranted. Remember, Apple has used these same excuses in the past. Peter Oppenheimer has set the stage for a staggering beat any way you slice it. To expect another leg down in Apple stock after the January 23rd earnings report is difficult to reason. So far, there are no signs suggesting any sort of year over year decline in EPS like the street is forecasting. This kind of disconnect means the market has it wrong in the short run. Apple bears will soon pull the plug.
4- China. CEO Tim Cook recently commented to Xinhua News Agency, "China is currently our second largest market, I believe it will become our first." Until Apple sales begin to slow in China, this is an investment thesis you do not want to miss out on. Among some of the fastest growing U.S. companies including Google, Amazon, Facebook and Twitter ... Apple is the only one without a Chinese counterpart. In fact, the Apple hype is so big in China that the company has had to implement a pre-order/lottery system to avoid product launch riots.
In the short run, the Chinese New Year hits on February 10th. During last year's new year celebration Apple was selling the iPhone 4S through a single carrier, China Unicom, and the phone was supply constrained because of the launch on January 13th for the January 23rd new year. Even with such constraints, Apple's Chinese revenue for the quarter totaled $7.9 billion. In 2013 Apple is more prepared for the new year shopping season, with the iPhone 5 launched at both Unicom and Telecom in December, and according to analyst Brian White ... insatiable demand for the iPad mini, this quarter stands to showcase Apple's strength in the region. To place Apple's China opportunity in proper perspective, consider that in the year ago March quarter, Google reported total revenue of $10.65 billion. Apple is on target to meet and even beat that number from Chinese sales alone in the 2013 March quarter. For an Apple bear, China isn't a sleeping giant, it's a sleepless giant.
5- Structural demand for shares. It's no secret that Apple trades as a market leader. As such, it is vulnerable to broad market conditions. Unfortunately for the bears, 2013 is off to a great start on the heels of a stronger than expected Chinese recovery, housing recovery, automotive recovery, and last but not least a market friendly Federal Reserve. Without global panic, it will be difficult to promote an Apple fear trade. In addition, Apple was one of the few dividend payers to hold true to the quarterly model while the herd raced to issue special dividends in December. Tim Cook's decision makes Apple even more attractive to income funds in 2013. Even more so if Apple increases the dividend, as many expect they will, in mid-March; consistent with the timing of last year's initial dividend announcement. Demand for Apple shares will also be driven by institutional alpha hunters who have waited to re-enter since the massive re-balancing occurred prior to the fiscal year end on October 31st; back when Apple had YTD gains of 74.9% and funds were forced to sell in order to comply with allocation maximums. And don't forget all those investors, led by David Tepper, who sold Apple in December to take advantage of lower capital gains rates. That group is allowed to re-enter Apple after a month-long wait period. This structural demand for shares is somewhat unprecedented for Apple considering it has never faced the kind of structural selling that it endured during the final quarter of 2012. As soon as sentiment flips back in Apple's favor, and it tends to happen quickly, there will be plenty of buyers jumping in. The bears could be facing a stampede of bulls in February.
6- Enterprise growth. Gene Munster's CIO survey revealed that 57% plan to deploy tablets in 2013 compared to 46% in 2012. 15% of those anticipate a broad deployment compared to 4% last year. Munster said, "We view the greater deployment of tablets as a positive for AAPL given that we believe the iPad has over 60% global tablet share and likely a higher share among enterprises. We believe continued growth in enterprise tablet deployment will help drive continued growth in the full sized iPad segment given the larger iPads are better for content creation."
Keep in mind, we are still in the early phases of an enterprise transition from Microsoft to Apple. In a December article posted in CIO Insight, author Don Reisinger began by writing, "Apple has done the impossible ... for decades, the very thought of bringing Apple products into the corporate world was, for many IT decision makers, a joke ... nowadays things have changed dramatically. Apple products, including the iPhone, iPad and even Macs are entering the corporate world at a tremendous rate. CIO's are welcoming these devices." Reisinger believes that Apple is infiltrating the enterprise because of the following nine variables: The 'bring your own device' craze, consumerization, iPhone creates inroads, iPad everywhere, Windows 8 is an issue, employee productivity, app developers, Macs are more friendly, and design matters.
7- Summer comparable sales. Anybody who tries to downplay the sales effect of multi-colored iPhones needs to do a little history homework. On January 6, 2004 Apple introduced 5 colors of iPods, a decision that I consider to be the kickoff catalyst into Apple's hypergrowth phase. In the first quarter of sales, Apple reported a 909% year over year increase in iPod sales. Needless to say, consumers like color options. We saw it in 2011 as a result of the white iPhone 4 delay. Consumers waited 9 months for the white version. If this new lineup of phones comes out in May, it means the June quarter will be compared to the 2012 June quarter in which Apple sold 26 million iPhone units. Those 26 million units represented 28% year over year growth. That growth rate stands to improve dramatically with a May iPhone 5S release. Investors like to see increasing growth rates.
In conclusion, investors can be a fragile bunch. Apple's October earnings miss combined with structural selling pressure has caused a mist of darkness to come over this stock. Analysts are cutting estimates. Pundits are shouting that Apple's reign has ended. Nothing could be further from the truth. The trading range has found stability from which Apple will likely rally to new highs. Android profit competition is a myth. Oppenheimer's lowball guidance worked, which means the January 23rd report is ripe for a beat. The Chinese New Year will spur sales in the March quarter. Enterprise transition to Apple is in its early stages. Multi-colored iPhone 5S's could lead to massive revenue growth (even approaching triple digits when combined with the new iPad mini retina) in the June quarter. A change in Apple sentiment is coming soon. Those who remain in the bearish camp are looking at some serious sleep deprivation.
Disclosure: I am long AAPL.