- Apple reported in-line quarterly results, though investors should focus more on the expected new product launches in the Fall.
- iPad sales were hurt by a cut in channel inventory, but a high percentage of new buyers and strong China growth were quarterly bright spots.
- With $135 billion in net cash and $6.40 in earnings power, Apple is still very cheap and should be bought at current levels.
After the bell on Tuesday, Apple (NASDAQ:AAPL) reported quarterly earnings that were generally in line with consensus, and as a consequence, shares bounced around the unchanged line in the after-hours session. To be honest, this reaction makes perfect sense because this quarter is not that important, as Apple's products are approaching a refresh cycle. In the Fall, we should see a new iPhone, probably a new iPad, and perhaps even a wearable device. The success of these products will determine Apple's growth profile in 2015 and 2016. While there are still important data points in this quarter, Apple's longer-term performance is going to be far more impacted by what happens in September through December than over the past three months.
In the quarter, Apple remained a profit machine, earning $1.28 on sales of $37.4 billion, while analysts were looking for $1.23 on sales of $37.9 billion (financial and operating data available here). Sales growth was a solid 6% year-over-year, while EPS jumped 20% year-over-year, thanks in part to Apple's aggressive share repurchase program. Apple was able to best earnings estimates despite lower-than-expected revenue, because gross margins were appreciably higher at 39.4% compared to 36.9% last year. This number also was ahead of guidance of 37%-38%. A big driver of the margin beat was a slightly different mix of products than expected. 35.2 million iPhone sales were at consensus, but 13.3 million of iPads was a slight miss, while Macs beat with shipments of 4.4 million. Thanks, in part, to higher selling prices and more add-ons, Macs typically generate higher gross margins than iPads, which explains a large part of this gross margin increase.
None of these three product numbers are that surprising, and affirm the bulls' belief that Apple products remains exceptionally popular. While growth is slowing, it is important to note Apple is not near saturation. Half of the iPad buyers are first-time purchasers, which makes me believe the tablet market can still more deeply penetrate the consumer technology space. The iPad should remain a source of growth for some time. It should also be noted, a reduction in channel inventory played a role in lower iPad sales, and this phenomenon is to be expected ahead of a new product launch, as retailers don't want to be left with millions of old models. The IBM Corp. (NYSE:IBM) partnership should also help the iPad better penetrate the enterprise space as well.
Apple is also an increasingly international company, and emerging markets should help underpin growth. While Americas revenue was only up 1%, China was up 28% and is now 17% of revenue, thanks to the partnership with China Mobile. The rest of Asia (ex-Japan) was also up a robust 6%, while Europe continued to recover, spurring 6% growth. All in all, this was a solid quarter. Apple continues to see strong demand for products, while working down inventory ahead of new launches. Emerging markets are also a bright spot as Apple catches up after relatively late entrances in some countries.
Unsurprisingly, Apple continues to generate a ton of cash. Its cash balance was up $13.9 billion sequentially, and now totals $164.9 billion. Long-term debt is $29 billion, leaving Apple with a net cash balance of $135 billion. Unfortunately, about 84% of this cash is trapped offshore, and it does not appear that a repatriation holiday is imminent. Apple is aggressively returning its excess cash to shareholders, with $5 billion in stock repurchases this quarter alone. However, Apple is not buying back stock at the expense of investing in the business. After all, R&D spending jumped 36% to $1.6 billion.
Once again, Apple offered light guidance, but it likes to lower the bar to generate earnings beats. Gross margins of 37%-38% would be a sequential decline, while revenue of $37-40 billion was also a bit light. I expect Apple to meet or even surpass the top-end of its guidance, as it is prone to do, which suggests revenue of about $40.5 billion and $1.35 in EPS. Again, this quarter is unlikely to be overly critical, as Apple will not be launching new products until the very tail-end of the quarter or even the beginning of the fourth quarter.
At the end of the day, Apple is a cheap stock. It should earn at least $6.39 this year and $7.10 in fiscal 2015. Excluding net cash, Apple is trading 11.3x this year's earnings, which is an extremely cheap valuation. Even if Apple failed to generate much growth, its stock would still be attractive. In essence, investors get to buy a great company at an excellent value, with a free call that some new products like a watch can accelerate revenue growth. With its 5% revenue growth profile and the potential of acceleration next year on new product launches, Apple should be trading at least 14x earnings, or about $113 per share. After this quarter, Apple is still a buy. The long-term bull thesis is unchanged. Apple is performing well and is extremely cheap, and investors should stay long.