I always think twice about writing an Apple (NASDAQ:AAPL) earnings preview, since any even slightly-negative article about AAPL's prospects brings out the flame-throwers and those who have absolutely fallen in love with a company and/or its products, without distinguishing the difference between a company's products and its stock price.
That being said, there seems to be some semblance of sanity starting to percolate around AAPL, as expectations have finally become more tempered around the stock.
As we prepped for this preview, the first thing that jumped out at us from the numbers, is that while the consensus revenue estimate for AAPL's fiscal Q2 '14 quarter has been revised slightly higher since the January '14 report (Q1 '14), the consensus EPS number has been revised slightly lower, which tells us that the 50-so analysts that are modeling AAPL's quarter are still seeing some margin pressure.
When AAPL reports their fiscal Q2 '14 after the bell on Wednesday, April 23, analyst consensus as it currently stands per Thomson Reuters estimate detail is expecting $10.17 in earnings per share (EPS) on $43.55 billion in revenues, for expected year-over-year (y/y) growth of 1% and 0%, respectively.
At the time of the January '14 Q1 '14 quarterly results, fiscal Q2 revenues were expected at $43.537 billion while EPS was then estimated at $10.31.
While fiscal Q1 '14's results were good, Q2 '14 guidance just killed the stock following the January '14 earnings report. Apple iPhone supply was one issue, as unit sales came in at 51 million versus the 56 million expected over the holiday quarter.
Hence, you can see how consensus revenue estimates were pulled higher over the last 3 months, while EPS was lowered slightly or by 1.5%.
Are the amounts enough to be material? Maybe not, but it is like a tell at the poker table: you get a feel for how the analyst community is leaning.
To keep our earnings preview brief and digestible, here is a quick summary of where we think the stock is going:
a.) We think fair value on AAPL is currently $600 per share, which means the stock is anywhere from 10% to 15% undervalued (at least without revenue growth, as you'll see in b below);
b.) Forward consensus estimates for revenues for the next 3 years are 5%, 6% an 6% respectively (fiscal '14, fiscal '15 and fiscal '16 respectively, while earnings growth for the same years are expected at 7%, 9% and 8% respectively. Compare this to the 40%-60% revenue growth for AAPL in 2009, 2010 and 2011, and you can quickly see why the stock has stagnated);
c.) Wearable technology, iBooks, AppleTV, the deal with Comcast, the iWatch, etc. are all potential growth areas, but can they move the needle on a company with expected revenues of $200 billion in early fiscal 2015?;
d.) Cash-flow and free-cash-flow have been flat the last 5 quarters as unit growth in iPhones has slowed and the company starts targeting lower end tablets and phones;
e.) What worries me is that while the smartphone market has clearly preferred bigger screens, AAPL has resisted that progression, and that is never good, i.e. management doesn't seem to be listening to the consumer;
f.) The overwhelming positive around AAPL is the roughly $160 billion in cash on the balance sheet, which translates into $176 per share, which AAPL hasn't decided what to do with yet. Carl Icahn took a run at management and tried to convince Tim Cook to return more cash to shareholders, but that may have only been a ploy to goose the shares from Carl's PR team, and Mr. Icahn looks to have given up on initiative (Doesn't mean he can't come back). Like most companies with large cash balances and strong cash generation, AAPL is hamstrung by the amount of cash custodied overseas.
g.) One positive I've noted from the numbers is that fiscal 2015 EPS numbers are once again starting to turn higher in terms of revisions, but that could be from share repo's, although fiscal 2015 revenue estimates are starting to stabilize and improve slightly too;
Remember 'intrinsic value' estimates are just that - estimates of a stock's perceived true valuation, and when dealing with companies and managements, an intrinsic value estimate often can be a moving target.
If AAPL can start generating revenue growth once again, I think the intrinsic value estimates start to get taken higher, but then AAPL has the "law of large numbers" to deal with given its $468 billion market cap.
In terms of the Wednesday, April 23rd earnings report, there seems to be a tempering of expectations, which could lead to pleasant surprises down the road. I don't think we will ever return to the 50% growth rates of the years prior, but the nature of the technology cycle is that tech companies have to reinvent themselves to survive.
Here is our January '14 earnings preview and then again our earnings preview last October '13 here. As we noted in one of the previews, I do think 15% growth is the limit for AAPL, but given the current expectations, that would likely drive the stock higher.
We are turning more positive on the stock (although we haven't added to any of current positions in some time), since expectations have come way in on AAPL, and the stock has lost some of its cult following and frenzy. We maintain a 1.5% position in client accounts, which is way down from the 5% position we had in AAPL in the fall of 2012.
With AAPL trading at 6(x) cash flow (ex cash) and 7(x) free-cash-flow (ex cash) and with the prospects of the dividend growing nicely, we think there is little downside for the shares, as long as you can wait for some revenue growth to materialize.
At $525 per share, and with a volatile but flat market year-to-date for the S&P 500, and growth stocks getting hammered, AAPL might be the perfect stock for this market. I now think there is more reward than risk to AAPL at $525 per share.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.