Since Apple (AAPL) released its fiscal first quarter earnings report, I've received dozens of questions regarding the company and the stock. Apple shares are 33% off their all-time high, and the bearishness surrounding the name has been increasing by the week. I have been planning for a couple of weeks on doing an article to answer some of those questions I've been asked. While I won't be able to answer them all, I'm going to answer as many as I can and to the best of my abilities. Here are my answers to your Apple questions.
What's going on with gross margins?
One of the biggest fears when it comes to Apple is that gross margins are dropping, and fast. There are a variety of reasons, and the iPad mini is definitely one of the most popular reasons. But I've argued this point before, and I'll make it again. Apple investors were spoiled during this time last year, as Apple's gross margins reached unusually high levels. This occurred for the following reasons.
- In fiscal Q1 and Q2 last year, Apple benefited from the iPhone 4S. This phone had a high margin, and accounted for more than 50% of the company's total sales in each quarter.
- The iPhone 4S was released in mid-October 2011, which pushed the buying cycle back a bit (the iPhone 5 was released in mid to late September 2012).
- The iPad 2 was reaching the end of its original cycle, with the third generation being launched in March 2012. iPad revenues as a percentage of the total were lower, helping margins.
In my opinion, Apple investors were spoiled by the high margins, and expected them to continue. This year, Apple had its largest product launch of all time. The iPhone was completely redesigned, with a larger screen, new display, and several other features. Apple also launched the lower margin iPad mini, a new iPad, as well as several other new products. Apple product launch periods are usually lower margin, and that is what we are seeing now. Additionally, because the iPhone sales timeline was moved up almost a month, a lot of the iPhone sales we saw in fiscal Q2 last year won't occur this year. Add in the lower margin iPad mini, and margins are coming down, for now. However, I think that after the next quarter or two, we will see margins rebound a bit. Apple will have a new version of the iPhone 5, and when iPhone sales represent a larger portion of the total, margins will rebound. It's a cycle, and it should repeat itself. The chart below shows gross margins over the past few years.
I believe we are towards the lower end of the range currently, but like I also said above, I think everyone was spoiled by the high margins. I expect Apple's gross margins will be in a channel between 36% and 44% going forward, with a majority of the quarters in the 38% to 42% range, depending on what products are launched when.
Why has Apple fallen?
This is a very good question, and one everyone thinks they have an answer to. Here are my main reasons.
- Growth expectations were too high.
- Tax based selling. With tax rates going up, a lot of people wanted to take advantage of the lower rates. Profits were taken, losses were taken, and we're now starting to see money re-enter Apple.
- In addition to #1 investors are looking for growth. Thus, they have rotated into other investments.
I really want to expand on reason #3. As Apple's growth prospects have come into question, I believe that investors looking for growth have swapped out of Apple into other names. Now, these may not necessarily be names that are purely growing faster than Apple. They are names that could also have been beaten down and are looking for a rebound in growth. So the following table shows Apple's performance against eight other names, adjusted for dividends, as well as the S&P 500 (SPY) ETF, since 9/19/12, Apple's high close. These names include two technology names related to Apple - Google (GOOG) and Research in Motion, now Blackberry (BBRY). I also threw in the "momentum" names that are usually associated with high growth. A few of these names were beaten down, and have now soared as their businesses have improved. This list includes names like Priceline (PCLN), Intuitive Surgical (ISRG), Green Mountain Coffee Roasters (GMCR), SodaStream (SODA), Netflix (NFLX), and Mastercard (MA).
Sometimes, investors just sell what isn't working and buy what is. Netflix is the funny one. Apple and Netflix released earnings the same afternoon. After Apple's report, Apple started declining from $500 to $480 to around $460. While that was happening, Netflix was rising from $120 to $130 to $140. There was definitely some rotation there.
New product launches: what and when?
What's next for Apple is a question I get asked often. There are several items I'm always asked about, and they include a larger screen iPhone, cheaper iPhone, a television, etc.
Here's what I think we will see this year. I think that the next big ticket item will be a new iPhone, perhaps the 5S, sometime in late spring or early summer, maybe June perhaps. This could be the "cheaper" iPhone everyone is talking about. I think we could also see the iPhone 6, which would perhaps be the larger screen iPhone, later in the year, possibly for the holiday season. With the launch of these new phones, there is also an expectation that Apple will launch a streaming radio service. If this were to happen, I would look for the service to be with the iPhone launch in late summer or early fall.
Last year, Apple came out with a new iPad in March. I would have normally thought that a new iPad 5 could come out in March this year, but they only launched the fourth generation version in mid-October. Thus, I think you are looking at a fall launch for that product. I think the same is true for the iPad mini refresh. Because demand for the mini has been strong and Apple had trouble filling those orders for a while, I don't think they'll be in a rush to launch the new mini right away. Look for a late summer or fall launch here as well.
As for other potential products, I think you are looking at 2014 or later. These include both the television and possible iWatch as well. At this point, other than a cheaper iPhone in a few months, I do think that Apple is a second half of the year story in terms of product launches.
I also get a lot of questions regarding Apple and China Mobile (CHL). China Mobile has almost 700 million subscribers, with more than 70 million of those being 3G subs. Those that are looking for Apple to rebound are looking for a deal to get the iPhone to China Mobile. Once Apple does this, revenues and profits will again accelerate. My feeling on this one is that a deal will be reached either this year or next.
What is your price target on Apple?
A lot of people want to know where I think Apple's stock is going. When I did my 2013 predictions, I provided a price target table based on Apple's fiscal year earnings. I have since updated that table, found below. I lowered the earnings range as we now expect lower earnings due to decreased margins and lesser sales. I also took down the top end of the valuation range, and have narrowed the range to 0.25 per P/E point per dollar of earnings.
*Adjusted figure - Apple had a 53-week fiscal year last year. This figure is normalized for a 52-week period and normal 13 week fiscal first quarter, as opposed to Apple's 14-week period in Q1 of fiscal 2012.
For some of the lower earnings points, the new P/E might be higher than the old table. Why is that? Well, these are the numbers I am projecting based on what we know today. I also think my original range was a bit too great, so I've narrowed it a bit. There is one important fact I want you to remember. This table is based on what we know today. As items change, I will continue to update the table. This could include increases/decreases in earnings, dividend raises, etc. As of Friday, analysts were expecting $44.75 in fiscal year earnings. That means my price target for Apple, by the time they report earnings in October, would be approximately $545. Again, this is as of what we know currently. This target will most likely change, and I will update it whenever I feel necessary.
Should I buy or sell Apple?
This is perhaps the question I get asked the most. However, there really isn't one uniform answer to this question. It really depends on each individual investor. Are you young or old, willing to speculate or relying on an income stream? Are you looking for growth or value? Are you willing to take some risk? Those are just three questions I could ask you back, and there are many more.
But to give part of an answer to the question, let me say some things about those looking to buy Apple. I'll use a baseball analogy. Apple will most likely be a singles or doubles hitter going forward. Apple is not going to be a super slugger that will double in a couple of months, and if you're looking to turn one dollar into five, Apple isn't for you. Additionally, if you are looking for a company that will probably pay a fair amount of dividends going forward, Apple would be a good bet. While the dividend isn't the largest out there now, Apple certainly has the cash and should raise it nicely going forward. Apple will come with some risk however, as it is a market leader. Everyone wants to take shots at Apple, and this is certainly not a risk free stock.
For those looking to sell Apple, it again depends on your situation. Are you selling at a gain or a loss? If you are thinking of selling Apple, you really need to ask yourself this one question. Do you have somewhere else to put your money instead? If you think there's a better place to put your money, then you should definitely sell Apple. Don't sell Apple unless you have a plan for where that money will go. Don't sell Apple just to sell Apple.
When it comes to Apple, I've received a ton of questions since the last earnings report. Today, I've attempted to answer a bunch of those questions. Now, there's one big question you might think I've missed, and that is the question about Apple and its cash. Don't worry, I haven't forgotten about Apple's cash pile. The answer to that question will come later this week. I have planned an entire article on Apple's cash and what they should do with it, because there is a lot of possibilities I will examine. Look for that article on Thursday.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.