Apple: Plenty of Upside Left

I was on my way to O'Hare airport last Monday when Apple (AAPL) reported its 4Q09 results. The conference call (see transcript here) occurred while I was in the air on my way to New York for business meetings. It was the first earnings conference call I have missed since my first purchase of Apple stock for clients in early 2005.

I think it is fair to say that Apple had an outstanding quarter. The fact that the stock jumped $10 in after hours trading and added another $5 to gains during the rest of the week pretty much tells you all you need to know. Apple is hitting on all cylinders and the outlook remains robust. Fears that the global recession and very pessimistic consumers would hurt sales and profits have proved completely incorrect. Apple always provides lots of statistics and analysts like me parse them endlessly but two statistics from the latest quarter capture the Apple investment story. First, total corporate revenue grew 25% year-over-year. With the global economy at best just emerging from recession, the fact that Apple can grow at 25% is mind boggling. Second, sales of Mac laptops were up 35% in units on just a 6% drop in average selling prices.

Apple is rapidly gaining share and is not being forced to compete on price. Apple is being driven by a relentless pursuit of innovation, quality products, great customer service and a still under-appreciated superb operating management. The company remains a market share gainer in Macs and iPhones and the runway in both product lines is long as current market share remains modest.

A few other key statistics form the quarter jumped out at me. iPod units were down 8% as the category is mature and the iPhone cannibalizes iPods. However, the incredible success of the Touch allowed ASPs to reach their highest level since March 2008 so iPod revenue was flat.

Also contributing to the great quarter, especially at the margin level was a 30% surge in software sales. This reflects rapid adoption of Apple's latest operating system, Snow Leopard. Software has very high margins so this boost contributed to an all-time record operating margin for the quarter and the second highest gross margin in recent history.

On a geographic basis, strength was particularly evident in Europe and Japan with revenues up 45% and 36%, respectively. The extension of Apple's brand abroad, driven by the iPhone, provides more room for long-term growth as only in America could Apple's market shares even be argued to be near maturity.

Apple shares usually respond to guidance commentary on the upcoming quarter. For 4Q Apple guided to revenues inline with the current consensus. This is very unusual as guidance is almost always below estimates. For Apple, the guidance is the equivalent of a positive surprise making this the proverbial "beat and raise" quarter that Wall Street loves. EPS guidance was below estimates but better than expected and once again looks to have very conservative margin assumptions.

One final point…Apple's accounting for iPhones as deferred revenue has created some confusion though no controversy. To get a sense for how much Apple is understating its profits, consider that to date the company has shipped 33.8 million iPhones, recognizing $8.8 billion in revenue or just $258 per unit. However, Apple is probably receiving $600 plus per unit from AT&T (T) and other wireless providers around the globe.

If Apple were to realize iPhone revenues when units ship, as do Nokia (NOK), Research in Motion (RIMM), and Motorola (MOT), EPS in 2010 might be north of $12 per share. The company also has $37 per share in cash on its balance sheets that is contributing just 20 cents per share with interest rates near 0%. So at $207, the stock is really trading at $170 with maybe $12 in EPS in the year ahead. That leaves the P/E at a quite reasonable 14 times given the still excellent growth potential in iPhones and Macs. Recent analyst price targets in the $250 to $300 range seem quite plausible, representing a low 20s multiples of EPS unadjusted for the pristine balance sheet.

Disclosure: Apple is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts.

Comments

[pftittl:]

At some point they may stumble, but their strengths should be emulated by all American businesses. Our country needs more Apples.

Oct 25 10:21 AM

[mollytjm:]

good article. i do think Apple will continue it's growth in market share in the U.S. as more people buy iPhones and Macs but also as both start making inroads in industry. Vista and a not good enough w7 gave companies time to see how expensive IT departments are. Apple has such wonderful customer support but their products are also less glitchy and virus prone, and are more intuitive, so easier to use. This all adds up to $$$ saved, so that initial buy, which might seem a bit above the price of a pc, really ends up costing companies less. Those that do try Macs, don't usually switch back.
Convenience is the name of the game for the iPhone. when i travel i always need my games, books, all weather radio, alarm clock, flashlight and on and on. i couldn't believe how many things my iPhone replaced!! I routinely read (and listen) to books on it now and play games on it. I never thought i'd do either on something that small, but it all just works.
There really is no limit in sight for the growth of Apple. 2020 won't have the names of a lot of companies we have right now...but Apple will be there...still growing and making money.
long APPL

Oct 25 10:28 AM

[VSD:]

apple will make $16/sh in 2010 assuming expected accounting changes and pick up in corporate computing. enterprises are seriously considering win7 vs. apple.

Oct 25 11:14 AM

[See through it:]

Apple's CASH earnings grew approximately 60% YOY for the last four quarters. The current GAAP growth rates come at less than 15%. The new GAAP accounting will bring the higher numbers to light and will justify a much higher stock price as the media continues to quote the misleading current GAAP numbers. Apple enters China next week and S. Korea sometime in the near future. Apple only has 3% of the addressable worldwide cell phone market and therefore has huge upside growth potential. The stock price can still go parabolic from the current level. Enjoy the ride.

Oct 25 12:17 PM

[Cranium:]

Nice job. The last paragraph is key, but I would actually have to disagree with one point. Apple's properly computed 14x PE is NOT reasonable! For a company growing at the pace of apple this gives it a PEG rate of isn't even close to 1!
For a company growing at it's present rate and with this type of sales momentum (through a recession no less) this is clearly not reasonable -- it is severely undervalued.

Oct 25 10:48 PM

[jack dee:]

>>>enterprises are seriously considering win7 vs. apple.<<<
pure nonsense,


Of course small companies can do what ever they want, But KO, JNJ , SNY global companies can not and will not bind to a single hardware vendor. until apple licenses OS to all hardware vendors corp will not consider apple as a serious option.


On Oct 25 11:14 AM VSD wrote:

> apple will make $16/sh in 2010 assuming expected accounting changes
> and pick up in corporate computing. enterprises are seriously considering
> win7 vs. apple.

Oct 26 12:57 PM

[jack dee:]

Mac has made no inroads to corp, you are talking about wishful thinking here. I would love to attend the meeting when the biz case for dumping wintel and moving to apple was presented.
If you were moving jobs, and wanted to get fired to avoid breaking contract, perhaps you might put a biz case forward, but otherwise most sane people understand it would be a complete nonstarter.

But then if you really believe that apple is making inroads against MSFT in the workplace, sure knock your self out.


On Oct 25 10:28 AM mollytjm wrote:

> good article. i do think Apple will continue it's growth in market
> share in the U.S. as more people buy iPhones and Macs but also as
> both start making inroads in industry. Vista and a not good enough
> w7 gave companies time to see how expensive IT departments are. Apple
> has such wonderful customer support but their products are also less
> glitchy and virus prone, and are more intuitive, so easier to use.
> This all adds up to $$$ saved, so that initial buy, which might seem
> a bit above the price of a pc, really ends up costing companies less.
> Those that do try Macs, don't usually switch back.
> Convenience is the name of the game for the iPhone. when i travel
> i always need my games, books, all weather radio, alarm clock, flashlight
> and on and on. i couldn't believe how many things my iPhone replaced!!
> I routinely read (and listen) to books on it now and play games on
> it. I never thought i'd do either on something that small, but it
> all just works.
> There really is no limit in sight for the growth of Apple. 2020 won't
> have the names of a lot of companies we have right now...but Apple
> will be there...still growing and making money.
> long APPL

Oct 26 01:35 PM

[Michael J. ...:]

I agree with you that AAPL is becoming more and more of an international story. Unfortunately, the naysayers continue to focus on the overall decline in iPods sales to suggest that AAPL is losing revenues. This is a canard as increasing iPhone sales are inevitably going to cannibalize iPod sale ... and that is a good thing. AAPL generates significantly more lifetime potential revenue from an iPhone as compared to an iPod.

Given MSFT's ineptness, both AAPL and GOOG will benefit at its expense. The demographics also support a long-term growth story for AAPL. I wonder if there are any statistics as to the age of the average AAPL user of iMacs, iPods and iPhones. My guess is that the under-30 crowd, for sure, represents the strongest AAPL demographic. If that is the case, it seems a virtual certainty that the growth story remains intact.

Oct 26 06:04 PM