Apple Hits A Home Run

| About: Apple Inc. (AAPL)


Apple reported earnings that easily beat Wall Street estimates thanks to strong iPhone sales.

Gross margins also jumped year over year, and the iPhone launch in China should power growth in coming quarters.

Apple also added $30 billion to its buyback, upped its dividend 8%, and announced a 7-for-1 stock split.

At 9x earnings, shares are attractive at current levels.

Apple (NASDAQ:AAPL) reported quarterly earnings after the bell on Wednesday, and it was a very eventful quarter. In addition to strong operating and financial results, Apple redoubled its push to be friendlier to shareholders by promising more capital returns and a buyback. Coming into this quarter, there has been a lot of pessimism surrounding the tech giant. Growth has slowed, and many investors have worried that Apple has lost its innovative edge under CEO Tim Cook. Given its secretive nature, Apple did not launch any new products, and we will likely have to wait until the second half of the year for product launches. Still, these results make it clear Apple is in a position of strength, and the sky is not falling.

Apple simply crushed expectations in the quarter. The company earned $11.62 compared to a consensus of $10.18 (financial and operating data available here). It also generated $45.65 billion in sales, comfortable ahead of consensus. Given these figures, it is no surprise shares popped 8% after hours. iPhone sales were also very strong at 43.7 million units. Analysts were looking for a more modest 38.45 million phones. This suggests that the iPhone launch with China Mobile (NYSE:CHL) has gone well. The only blemish in the quarter was iPad sales, which came in at 16.35 million compared to expectations of 19.8 million, though inventory fluctuations impacted sales. Mac sales were also solid at 4.1 million. International now accounts for 66% of Apple's revenue.

Importantly, Apple had a gross margin of 39.3% in the quarter, up from 37.5% a year ago. With sales growth slowing, there has been concern about continued gross margin erosion. However, Apple saw solid pricing power and actually expanded gross margins. This points to strong demand for Apple products around the world. As it further penetrates the Chinese market, I expect solid quarters ahead, especially for the iPhone. While Apple has been in an "evolutionary" rather than "revolutionary" innovation phase, its products remain extremely popular, and the company has shown tremendous resilience.

As usual, the company offered conservative guidance, predicting revenue of $36-$38 billion in revenue and gross margins of 37-38%. Given the results during the past quarter, I expect Apple to meet or exceed the high end of this range. Of course, Apple continues to be a cash machine as it generated $13.5 billion in operating cash flow. Under pressure from investors like Carl Icahn and others, Apple has begun to return more of its excess capital to shareholders. During the quarter, it returned $21 billion in buybacks and dividends, bringing cumulative returns to $66 billion under its current program. Thanks to this aggressive capital return, Apple's gross cash hoard dropped by $8 billion in the quarter to $151 billion, the first drop in years.

In addition to strong quarterly numbers, Apple promised to return even more capital to shareholders (press release available here). Management had previously expected to return $100 billion to shareholders by the end of 2015. It now expects to return $130 billion. The board added $30 billion to its buyback authorization to $90 billion. Over the next 20 months, Apple will be returning another $64 billion to shareholders in dividends and buybacks. To fund this buyback, Apple will continue to issue debt to avoid repatriating foreign earnings. That capital amounts to over $3 billion per month. This plan will keep Apple's net cash position from growing too fast over the time period.

In addition to the expanding buyback, Apple increased its quarterly dividend by 8% to $3.29, giving it a yield of roughly 2.3%. The board also authorized a 7-for-1 stock split in June, which would push the share price down to the $80 range. At this price, Apple would be a prime contender for a spot in the prestigious Dow Jones Industrial Average (NYSEARCA:DIA). Inclusion in the Dow is unlikely to boost shares appreciably as few funds are indexed to the Dow, but it would place Apple in elite company among U.S. blue chip stocks. A split does not add value, but it could incline some retail investors who don't like buying high priced stocks to consider a position in Apple.

Overall, Apple reported strong numbers. Gross margins suggest Apple maintains pricing power, and the company beat on virtually all metrics. iPhones were particularly robust, and China should provide further upside in coming quarters. Finally, Apple is increasingly shareholder friendly. Its dividend provides solid income for investors, and its buyback will help to accelerate earnings growth. With so much cash, a large buyback is a wise use of shareholder money. Apple is on track to earn $46-$49/share in fiscal 2015. Excluding its cash position, Apple is trading around 8-9x earnings. This valuation suggests Apple can never innovate again. Shares are more than pricing in the worst case scenario while ignoring future growth potential and the company's strong cash generation. Even at $560, shares are very attractive. I would be a buyer until $650. After this fantastic quarter, Apple remains a buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.