Apple (AAPL) investors were hoping for a blow-out quarter. Instead, they got a "blow up" as Apple missed on revenue and reported declining gross margins.
The result was brutal as Apple sank more than 10% in after hours dropping through my $480 price target. I got a lot of grief from readers when I went negative on Apple. My bearish forecast was spot-on.
Unfortunately, Apple is not done going lower. I've outlined before why Apple is a must-not own stock. You can see my reasons here and here. To review, Apple's profit margins are unsustainable. Last April, Apple reported a humongous 39% operating margin - crazy-high for a hardware company. That translated into Apple making an astronomical $263 on each sale before taxes. No computer or handset company makes anywhere close to $263 on each sale. Not even close. To put it in perspective, in its heyday, RIM (RIMM) made $126 from each unit sold. Apple had only one way to go as far as unit profits - down. This quarter, cost-conscious customers opted for the less expensive iPhone 4 and iPhone 4S rather than the higher margin iPhone 5. Operating margins tumbled to 31.6% from 37.4% year-ago quarter.
Moreover, Apple doesn't control any of its manufacturing or supply chain. That wreaked havoc this quarter. Apple found itself without enough product to sell because of supply constraints for the iPhone 5, iPad Mini, and iMac. When I predicted this a few months ago, readers went bonkers. Turns out Apple didn't have the goods. My concern was correct. It doesn't matter how much demand there is for your product - if you don't have the product to sell, you aren't going to get your sales. Apple recognizes the dilemma and is trying to get more control of production. Per CFO Peter Oppenheimer:
We are buying equipment that we will own that we will put in partners' facilities. Our primary motivation there is for supply, but we get other benefits as well.
Without more direct control, Apple's a sitting duck.
There are two key numbers in the myriad of earnings data to focus on:
1. Gross margins fell 610 basis points year over year to 38.6% as Apple met higher manufacturing costs. The drop in gross margin is probably not done. Apple expects margins to decline to 37.5% to 38.5%.
2. As mentioned, Apple isn't making as much money on each sale. Apple earned $196 before taxes on each unit sold, a $44 drop from the year-ago quarter. The declining unit profitability is the most worrisome stat out there. Apple has been able to boost its unit profits for 6 years. The consumer has been handing Apple higher premiums year after year. That trend started to break down in the July quarter. It's now shattered.
I wanted to make a special note: This time a number of analysts got it right. Tavis McCourt of Raymond James hit it out of the park with a perfect $13.81 EPS estimate and pretty darned close 48 million iPhone sales. Remarkable job. Sometimes we dump all over the analysts. This quarter, they did a great job forecasting. In fact, the pros' consensus of $13.45 was far better than that of the independent analysts' $15.11 with once-wunderkind Andy Zaky stuck out in left field at $16.85. The analyst community has been getting a better read on Apple and, going forward, investors would be wise to pay close attention to McCourt and Avi Silver of CLSA (EPS $13.85 on $54.8 billion revenue). They are the hot hands right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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