In today's Oxen Group recap, we will be looking at Apple (AAPL) as well as Cisco (CSCO) in our company news section. In our Deeper Look, we will examine Apple since our last update in December to cover the company's latest developments and update our model. In our Company News, we will look at the recent earnings report on Cisco and give our take on that as well as predict where we think it's going next. We cover AAPL year-round, and we follow CSCO on a limited basis. As always, we will also do our market overview and market recap.
The market was not as strong on Wednesday after a big run up on Tuesday. Mostly, we saw the market as awaiting developments on Thursday before making decisions as to higher upside or reversal from Tuesday's movement. On Thursday, the market will be reacting to key earnings from CSCO and CBS, Retail Sales, and more. As for Wednesday, the big news of the day was two separate developments in Europe and in Asia. The more important has to be what is going on in China (FXI) this morning. The country reported some very large numbers for year/year gains in January exports/imports. Exports rose 10% year/year versus less than 1% expectations and imports rose almost 11% versus estimates ranging from 2-4%. The Trade Balance came in at a surplus of $32B versus estimates that it would drop to less than $24B.
So, what happened?
China is definitely under scrutiny after a number of reports have highlighted that fake export invoices were being used to exaggerate exports and even imports. Additionally, the country counts trading to Hong Kong as exports as well, which skews the data. Yet, a lot of this has been cleaned up in recent months, so it begs the question...did China really grow at the rate they say they did? Hong Kong import data will release in 14 days, so we can update at that time. If this is true, it's definitely a relief for China and could be the start of a rebound for them.
In Europe, the news was anchored by the developments out of the Bank of England. The central bank gave some mixed news but overall fairly bullish. They commented that they would keep the borrowing rate at 0% for at least until 2015, as employment remains sluggish. Additionally, the BoE raised their growth forecast for 2014 to 3.4% from earlier 2.8% guidance.
The markets were not able to rally on positive foreign news, as the market was awaiting tomorrow mostly. The Dow Jones (DIA) fell 31 points. The Nasdaq (QQQ) added 10 points, and the S&P 500 (SPY) dropped one point.
In today's Deeper Look, we will be looking at Apple as the company begins 2014. In our latest article, we reiterated our Buy-rating in the stock with our $700 price target. We focused in on the 2014 developments in our last article with what would develop in the iPhone, iPad, iOS in the Car, and Apple TV. In this model, we are focusing in on the China Mobile deal's implications on 2014, iWatch developments, and update the iPhone/iPad/Apple TV.
With these updates, we have upped our price tag from $700 to $750.
In our latest update to Apple we looked at the big developments of 2014 with the release of the iPhone 6, new iPad, and potential for Apple TV. Here are some of the highlights:
For the iPhone:
2014 should be a revolution for the iPhone. After several models advanced slowly, many are looking to the iPhone 6 to really push the envelope once again. The confirmed push is for bigger screens on the iPhone 6 that will push the overall size of the phone even further, but we would not expect a drastically "big" phone, as they'll try to make the screen push from side-to-side. Another likely development will be continued push on processors. The A7 64-bit chip was a major upgrade, and it is hard to expect much more from there. The areas where the company could make hay and where a lot of investors will be watching are the battery, iBeacons, facial recognition, camera advancements, and motion sensing.
The iPhone is the big winner for 2014 as well as China Mobile, which we will get into shortly.
For the iPad:
On the iPad side, the company is likely to release a new model in early 2014. Expectations are that the company will build a supersized iPad that is around 13in, which pushes the question even further as to what is the use of notebooks. Additionally, the new iPad will get a processor upgrade to at least the A7 and likely get some other bells and whistles that the iPhone 5S.
And for Apple TV:
Finally, the most hotly anticipated development in Apple history that has never happened still…Apple TV. 2014 looks to be the year for the company. Here is Ming-Chi Kuo speaking about the prospects: We expect Apple to launch a new version of the Apple TV with an A7 processor in 2014, and we forecast 2014 shipments to total 8.2mn units. Shipment growth will be limited unless Apple is able to integrate more TV content, services and its App Store, in our view. We believe the slowdown in Apple TV shipments suggests Apple faces challenges in integrating TV content and services. If Apple wants to launch iTV, the challenges of integrating content and service are more difficult considering the different TV content ecosystems (e.g. cable operators) in various countries. Moreover, establishing an iTV supply chain is very costly. Thus we believe iTV launch will be delayed to end-2015 or early 2016 at the earliest.
Since that last report, there have not been a ton of updates on these products. The latest reports are showing the Apple TV set-top box will release in March - April 2014. Rumors that fourth-generation Apple TV were spotted in iOS 7 configuration files, which makes it look like it will be the first big release for 2014. What type of sales can we expect for Apple TV? There were over 6M units sold in 2013, and we could see another 5-6M in 2014 with the new release.
The big news since our latest report was the development of the China Mobile (CHL) deal, which is finally finished! We have been talking about it for over a year, and the deal is big news and has large implications for the company. Getting in with China, puts Apple in a much better condition to attack in emerging markets. CHL had 763M users in the latest figures. The company noted prior to the deal that there were 45M people using their phones - mostly acquired from foreign markets. That number accounted for about 60% of total iPhone users in China.
The prospects from the deal are exciting. A lot of people have covered the deal, but we see the deal adding around 2.25 - 2.75 in EPS as the company will make around 12-15M sales to CHL users in 2014. With an ASP of $630 (but potentially lower in China), should add a solid amount to EPS. We are going a bit more conservative in our model due to initial sales have been a bit weaker than were expected, and it may take some time to get the sales moving. Right now, Apple is only in 16 cities, but that could reach 340 by the end of the year.
This development will be crucial to watch, and it needs to start to strengthen in the Q2-Q4 period. We will be updating throughout the year.
Another development we are watching is the iWatch. Will it happen? Is it a game changer?
In January, Corning (GLW) noted that they were ready to manufacture curved Gorilla Glass for curved glass products. This is one of the first developments that could lead to the iWatch being released. Rumors from the Financial Times suggest that the company is getting designers and technical experts together to try and form the watch to the Apple standard. The details, though, are still sketchy. The size is unknown. Some potential ideas are that it will have a solar charger. One of its best features will likely be its use of Maps.
So, what are the prospects?
Tough to predict at this point. One analyst speculates that it could be $149 - $229 in price, but Morgan Stanley has noted that the iWatch could produce around $17B-$18B in its first 12 months with growth from there as it expands markets and models. Details are still to come, but we are looking at a lot of potential here if the company can really make this happen.
2014 is a great year for Apple, and we believe it's a year for the company to get back on track. Gone are the days of major rallies for the company, but we believe that it will have another solid year with a lot of new products in a new product cycle.
Price Target Analysis
Revenue - The company currently has market share at 13% in mobile shipments and 30% in tablets. How will these shares develop in 2014? We would expect mobile to jump again. The catalysts we mentioned are going to be winners for AAPL, and the company also just inked a deal with China Mobile, which can add 8% in market share potentially. Both of these give Apple some definite upside in market share. Now, the competition is strong, but we would say a jump to 15-17% is conservative. Tablet market share will likely be flat as we expect better competition in 2014 especially from MSFT. Even so, that puts potential volume at 220M phones sold and 79M tablets sold. With an average sale price of roughly $620 per phone and $475 per tablet (which are likely low given the premium iPhone 6 and new iPad will likely reverse ASP back up), revenue from these products is likely to be $136B and $38B, putting revenue at $174B for these products alone.
How much can the rest of the business make?
PC sales are likely to decline, and we should see around $15B in Mac sales. The iPod will likely come in around $500M. iTunes will be on the rise with the launch iTunes Radio as well as the implementation into phones, so we could see that at $18B. Finally accessories should pitch in around $5B. We are looking at potentially $215B in sales. Some may say these numbers are lofty, but given the growth of the smartphone market and launch of iPhone 6 it will push sales to that area. This does not include the potential from the iWatch as well as Apple TV. Those numbers could come in around $5-$6M. Tablet sales are going to be strong. The one area that may decline further is Mac, but even in a most conservative approach - $220B looks possible in 2014.
If we use that number, and we take a net margin of 22% (accounting for a jump back up due to rising ASPs), we can see net income coming in at $48.4B, which translates to an EPS of 54.00. In this best-case scenario, we then take 54.00 x PE of 14, and we get share price at roughly $750. In a more conservative model, if we see AAPL lose market share in both phones and tablets and see net margin drop to 20%, we are looking at 200M phones and 65M tablets. In that scenario, revenue would be around $190B with net income at $38B and an EPS of 42.30. Multiplying that by current PE, we get share prices at $590 around current pricing.
These estimates, though, are just too low. The company is not going to see net margin decrease to 20% with new premium products out, and they are unlikely to lose that much market share. The only way that happens is if the company completely flops on these products, and that has not happened. Expectations of something between $590-$750 for 2014 are likely.
In today's company new section we wanted to review Cisco after we covered the company in our weekly outlook article. In that report, we noted that CSCO needed a positive report after some weakness in their previous report:
The last report for CSCO was a disappointing one as the company guided weakly after the stock had seen a tremendous run for a couple years. The company warned in their last report that both sales were going to drop to as much as 10% as well as see some "challenging" months. CEO John Chambers noted that CEOs were being cautious into 2014, and the company needs companies spending money to see growth. Their last report showed some light growth in revenue to $12.1B from $11.9B as well as EPS up to 0.53 from 0.48. The company beat on earnings and missed on revenue.
Today's report appears to have not improved much on the Cisco case. The highlights were that the company reported an EPS at 0.47 versus 0.46 expectations with $11.2B in revenue over $11.0B in consensus. The company boosted its dividend and repurchased $4B of stock in the latest quarter. The company guided at 0.47-0.49 EPS versus 0.48 expectations. The company expected a Q3 drop in revenue at 6-8%. Analysts had been expecting a guidance of only 4-5% revenue drop. Therefore, these results were a bit disappointing. The problem - hardware sales and competition.
Signs of problems are the drop in gross margins to 53% from 61% and a 55% drop in net income. The company is definitely in transition mode as they want to become a networking consultant:
Mr. Chambers said in an interview that he's still leaning on Cisco's networking strength: Cisco will sustain its high margins by offering companies and governments deep insights over big systems, like the workings of a major global manufacturer, or the efficient running of a big municipality. Other developers who want to build products within this Cisco environment will also benefit, he said.
How is that going so far?
From the earnings call:
There is no question that we have moved from a compute centric to a network-centric model for IT. Cisco is building the simple, smart and highly secure solutions that will enable our customers to capitalize on the cost efficiencies, agility and growth opportunities that lie ahead. Our approach is unique. It starts with the central role the network, which is the only place to connect everything, people, process, data and things. Our transition is from selling boxes like most of our peers to selling business outcomes. Our delivery is through architectures, partners and services and we will help our customers utilize their 180 billion Cisco install base to capture the most value today and build for tomorrow.
The company is definitely in a transition phase right now, and the future looks not bad but definitely will take time to develop still. The company highlighted five things to watch as they move to a network-centric company that we want to take note of to watch moving forward:
1. The Internet of Everything - the company noted that it's a "business imperative" now, and that it is at the tipping point of a major revolution.
2. Enterprise/Commercial - the company is showing strength at home with year/year orders up 13% in enterprise and 10% in commercial, and the company is confident in their architectures.
3. Emerging Markets - weakness remains but the company notes it is cyclical rather than a change in the makeup of the environment
4. Architectures - investing in "Cisco's ability to bring together technologies, servers and solution across silos should continue to drive differentiation, preference and, over time, gross margins."
5. Building backlog - The company exited the quarter with book-to-bill greater than one, and it is building a product backlog.
Overall, the results show a company in transition, and we believe that the company is one to watch right now. Weakness should remain until results start to change, but for now, we are expecting a bit more weakness to remain. In our earlier article, we noted that in order to get out of this funk, Cisco had to show some strength in emerging markets, and while the transition is going well, these markets are still cyclically weak. Despite doing a decent job getting over the low bar, the company still has more to prove.
Thursday is an important day for the market as we get Retail Sales, reaction to CSCO as well as CBS earnings, and more. Retail sales for January will be released. The month was mired with bad weather, and results, therefore, could be a bit weaker than expected. The report is expected to come in at flat versus 0.2% rise in December. The weather being the culprit, which hurt the employment number as well. A major miss will hurt but a slight miss might be forgiven. Additionally, on the data front, we get jobless claims. After weak employment numbers to start the year, these numbers will be key to the market as well.
Cisco should hurt the market, but CBS was a positive report. The company reported solid sales numbers and earnings, which should help. Tomorrow morning, we get reports from VF Corp (VFC) and Campbell (CPB). Additionally, Fed Chair Janet Yellen will give her testimony to the Senate, which is likely to mostly rehash Tuesday.
Overall, it's a big data day that will definitely move the market, so we need to be sure to watch closely. Expect volatility in either direction of the reports are either strongly beaten or missed as the market tries to know what's next.