Apple (NASDAQ:AAPL) is scheduled to release its March quarter results on Wednesday, April 23, and if it maintains its usual practice, will provide guidance for the next quarter in its press release. While I am not very concerned about Apple hitting investor expectations for the March quarter, I am very concerned about guidance. After running my Apple model for the June quarter and comparing it to the Street projections for revenue and EPS, I believe that the company's guidance could be significantly below expectations, which could lead to a substantial drop in the shares post-earnings.
Revenue guidance could show negative year-over-year growth
The Street is currently estimating June quarter revenue of $38.3 billion, which has come down slightly from $38.7 billion two weeks ago. The $38.3 billion is an 8.5% increase from last year's $35.3 billion result, which would mean management would have to feel comfortable that either carriers such as China Mobile (NYSE:CHL) and NTT DoCoMo (NYSE:DCM) or new products will kick in, since last year, the June quarter's revenue growth was only 1% year-over-year.
Last year, Apple guided June quarter revenue to be down 1.5% year-over-year at the mid-point of its $33.5 to $35.5 billion range. With the same 1.5% decline, the mid-point for the June 2014 quarter would be $34.8 billion.
While lower iPad and iPhone channel inventories negatively affected June 2013 revenue by about $650 million, I believe management will be extremely cautious given all the rumors floating around about a larger-screen iPhone 6. When I do my bottom-up revenue projection based on unit sales and average selling prices for iPhones, iPads, Macs, iPods, iTunes and Accessories, my June quarter revenue estimate is $33.7 billion. Therefore, it would not surprise me to see the mid-point of guidance at $34 billion, with a range of $33 to $35 billion.
iPhone 6 rumors are in full swing, and should affect guidance
After selling just over 51 million iPhones in the December quarter and an estimated 37.4 million for the March quarter, I am expecting iPhone units to decline 23% sequentially when adjusted for channel inventory.
The 23% sequential decline would be a greater decrease than the 19% Apple experienced in 2012 with the 4S, when normalized for channel inventory changes, which I believe is more relevant than 2013's 13% decline with the iPhone 5 that had a larger screen size. This would be a 12% year-over-year decline and potentially be the first year-over-year decline for iPhone units, unless the March quarter comes in under the 36.43 million that were sold in the March 2013 quarter (again, adjusted for the 1 million channel fill).
While China Mobile and NTT DoCoMo will help, since this will be the first June quarter that they will be selling iPhones, I believe there is so much buzz about the iPhone 6 that Apple will be very conservative on the number they assume they will sell when calculating guidance.
iPads seem to have hit a plateau
iPads should also experience a weak June quarter, since Apple has changed its product release cycle to the holiday time frame. In June 2013, iPads declined 15% from the March quarter, and I am assuming a 17% drop this year (18 million in the March quarter to 15 million in the June quarter). On a year-over-year basis, 15 million would be a 3% increase on a reported basis, but down 2% adjusting for the 700,000 unit decline in channel inventory a year ago.
Overall, it seems like iPads have hit stall speed, with year-over-year unit growth the past three quarters of minus 3%, plus 2% and plus 5%, respectively.
Gross margins will be critical as usual
In June 2012, gross margins declined 460 basis points sequentially, and in 2013, it declined a reported 60 basis points, but would have been about 160 basis points when normalizing for an additional warranty charge that was taken in the March 2013 quarter.
While it will depend upon the March quarter's gross margin, if you assume a 37.0% gross margin for the June quarter, it would match the low end of the company's 37%-38% guidance for the March quarter. So even if the March quarter's gross margin comes in at 38%, the decline for the June quarter would only be 100 basis points. It seems reasonable that guidance for the June quarter could be similar to last year's 36%-37%.
The low end of EPS guidance could start with $6
While Apple doesn't provide exact EPS guidance, it does give all the inputs to determine a range. When I use $34 billion as the mid-point of revenue guidance, along with a 37% gross margin, similar operating expense trends for the past few years and a share count of 864 million (down 37 million from the December 2013 quarter), I arrive at an EPS of $7.28.
While some sell-side analysts are warning about June quarter guidance (Keith Bachman at BMO Capital is at $7.47, Bill Power at Baird is at $8.17 and Steve Milunovich at UBS is at $8.20 vs. the Street at $8.51), I don't believe enough investors fully appreciate the potential downside to the guidance range that management may give. Since Apple gives a range for revenue, gross margin and expenses I would not be surprised if the low end of EPS guidance starts with a $6.
A larger buyback program or strong China Mobile could save the day
The "saving grace" part of EPS will be how many shares Apple buys back and if it announces a large increase to its buyback program. I would say it has to be at least an additional $25 billion, and more like $50 billion. I don't think the company can increase its dividend enough to offset a guidance shortfall, since it is limited by the amount of U.S. cash it generates on a yearly basis.
If it does announce a larger buyback program with some positive verbiage about new products, it may limit what I believe could be a downdraft in the shares the day after earnings are announced.
The other areas that could offset my concerns would be China Mobile kicking in faster than expected, recently lowered iPhone prices overseas driving incremental sales but not hurting gross margin too much, management "knowing" that the iPhone 6 could ship in the June quarter and including its sales in guidance or gross margins staying healthy.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. 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. Sand Hill Insights and Chuck Jones is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Sand Hill Insights/Chuck Jones does not purport to tell or suggest which investment securities readers should buy or sell. Readers should conduct their own research and due diligence and obtain professional advice before making investment decision. Sand Hill Insights/Chuck Jones will not be liable for any loss or damage caused by information obtained in our materials. Readers are solely responsible for their own investment decisions.