Apple Earnings Preview: Don't Expect The Moon

| About: Apple Inc. (AAPL)

On Tuesday, Apple (NASDAQ:AAPL) will release its earnings after the bell, and you know that everyone will be watching. Since I write about Apple a lot, I talk to a fair amount of people about the company, through e-mails, comments in articles, etc. After Apple's absolute blowout first quarter results, expectations seem to be really high, and I've had some people claim that they think Apple will post numbers close to those we saw in January.

I'm not that optimistic, but I still expect a good quarter. There are some curious things that people overlook when analyzing Apple, and I'll try to cover those in my preview here today.

First, there are a couple of things that people need to realize first when trying to figure out this quarter. First, it is not a holiday quarter. Last quarter was. Second, this quarter was 13 weeks long, the last one was 14. You might not think that is a big deal, but Apple averaged $3.3 billion in revenues per week last week. Take a week off, and you are talking about a decrease in revenues. Third, the iPhone 4S went on sale in Mainland China this quarter, and finally, Apple launched a new iPad during March. I'll get into some of these in more detail later.

Let me begin by analyzing the first thing I mentioned, the impact of a non-holiday quarter. Let's go back a year. The following table shows the dropoff in unit sales per product from the holiday quarter (Q1) to the non holiday quarter (Q2).


Q1 2011 Q2 2011 Change
Desktops 1,227,000 1,009,000 -17.77%
Portables 2,907,000 2,751,000 -5.37%
Total Mac 4,134,000 3,760,000 -9.05%
iPod 19,446,000 9,017,000 -53.63%
iPhone 16,235,000 18,647,000 14.86%
iPad 7,331,000 4,694,000 -35.97%

There is a seasonality to Apple's revenue and earnings, and you just cannot ignore that fact. As you can see, iPod and iPad sales took huge hits from one quarter to the next. Mac Sales weren't down by much, but there still will be a decline from one quarter to the next. You must remember this when it comes to analyzing Apple.

Apple is still crushing fellow "competitor" Research in Motion (RIMM). I put competitor in quotations because many would argue that RIMM isn't a competitor anymore. Apple is now selling more iPhones in Canada than Research in Motion is selling BlackBerries, and that is RIMM's home turf. Also, Apple sold more than a million iPads per week in Q1, while Research in Motion has only sold about 1.35 million Playbooks in the past four quarters. Is RIMM still a competitor? With another great quarter from Apple, it may not be.

So what do I expect for this quarter? Well, see the following table for my estimates per product.

Product Q1 2012 Q2 2012 Change
Desktops 1,479,000 1,275,000 -13.79%
Portables 3,719,000 3,475,000 -6.56%
Total Mac 5,198,000 4,750,000 -8.62%
iPod 15,397,000 8,000,000 -48.04%
iPhone 37,044,000 33,000,000 -10.92%
iPad 15,434,000 11,800,000 -23.55%

You may think that some of my predictions are a bit conservative, but remember, it is not a holiday quarter, and we have one less selling week. Again, it does make a difference. I'm still expecting large year over year growth numbers for the iPhone and iPad, and decent growth for Mac sales. I think iPod numbers will continue to decline.

So when I add all of that up by my estimated sales price, plus some other revenues Apple could generate, I get an estimated revenue number of $39,171,750,000. For simplicity, let's just say $39.17 billion. That is currently above Wall Street's current $36.63 billion estimate, and well above Apple's $32.5 billion given guidance, which we know is usually very conservative. The highest estimate on the street currently is $41.1 billion. In terms of year over year growth, my expectation calls for 58.8% growth.

Now that I've given you my revenue number, let's work our way down to an earnings per share number. The current Wall Street estimate is for $10. Now, I think that number is a bit low. Why? Well, if you take the $10 earnings per share estimate, and the $36.63 billion revenue estimate, that means that net profit margins for Apple will be about 25.74%. Apple's first quarter net profit margin was 28.2%. There is no way that Apple's net profit margins will fall off by more than two full percentage points. It just won't happen.

Now, Apple has improved its margins over time, but its margins also get a boost when the iPhone is a bigger percentage of revenues, since the iPhone is a higher margin product than some of Apple's other products. The following table shows this impact. The iPhone sales % number is the percentage of revenues that come from iPhone and its related products and services.

Margins Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012
iPhone Sales % 39.15% 49.86% 46.59% 38.84% 52.70%
Gross 38.51% 41.42% 41.73% 40.25% 44.68%
Operating 29.27% 31.92% 32.83% 30.81% 37.42%
Profit 22.45% 24.27% 25.58% 23.43% 28.20%

If you notice in Q1, the iPhone was more than half of Apple's revenues, and margins jumped substantially. Now, based on my forecasts for this quarter, I have iPhone revenues being 55.18% of total revenues, a number higher than the Q1 number, so I expect even more margin growth. However, we have heard talk that the new iPad costs Apple a little more, so I'm not going to give Apple substantial margin growth. The help from the iPhone will be partially offset by extra costs from the iPad.

So for this quarter, I am expecting 45% gross margins, a 32 basis point increase from the Q1 number. Since Apple has been able to keep general costs under control, I see a little more margin improvement when it comes to operating margins. My forecast is for 38% operating margins, which is a 58 basis point improvement over last quarter. For their net margins, I expect even more improvement. Why? Well, with the iPhone 4S going on sale in Mainland China this quarter, I expect Apple will see a lower percentage of sales from the US. Because of this, I expect Apple's effective tax rate to decline a little. Thus, I expect net profit margins to be 29%, an 80 basis point improvement over the prior quarter.

Using my revenue number and an estimated diluted share count of 944 million, my earnings per share number is $12.03. I realize that this is much higher than the street estimate of $10, and even the highest street expectation for $11.80. However, it is still down almost $2 from the previous quarter. The one less week and non-holiday quarter will hurt, but some margin improvement will help offset those decreases.

Now, we know that Apple usually gives conservative guidance. Current street estimates for Q3 call for $37.37 billion in revenues and $9.92 in earnings per share. I'm guessing that Apple will guide to about $34 billion in revenues and about $9.50 in earnings per share. That's just my guess knowing their conservatism.

For the full year on Apple, my current estimate for revenues is $162 billion. My earnings per share estimate is $48. Since I'm giving Apple a 14 times earnings multiple, my price target for this fiscal year is $672. Remember, Apple's current fiscal year ends in September. For next year, I am at $55 in earnings per share, which means a $770 price target (using the same multiple at the moment).

So what to do with Apple before earnings? Well, we've dropped a bit the last few days, and are now at just $573. Apple has seemed to fall out of favor recently, along with fellow tech giant Google (NASDAQ:GOOG). Google has declined since its earnings report, where revenues were just in line. Also, Google announced a confusing stock split using non-voting shares, which has put some uneasiness into investors.

As I argued in a recent article about Facebook's (NASDAQ:FB) impact on Apple, you should sell Google instead of Apple if trying to free up capital to buy Facebook shares. Also, part of Apple's drop on Friday may have been partially due to the great earnings number from Microsoft (NASDAQ:MSFT). I'll have a separate article out on Microsoft, but here are some basics. Microsoft beat on both the top and bottom line, thanks to strong sales from Windows and Office. That could potentially hurt Apple a little. The great report from Microsoft sent shares up more than 4.5% on Friday, and Apple was down 2.5%. Some investors might have taken some money out of Apple and put it into Microsoft.

Given Apple's 52-week high of $644, there is still plenty of upside in the name. If you are a long-term investor, I would recommend holding Apple through earnings. If it jumps, you win. If it falls, you can buy more at a lower price. For shorter term investors or traders, I probably would recommend staying on the sidelines, but if you want to be in the name, I would recommend buying it if it was between $550 and $585 going into earnings. I'd be a little more cautious above $585, and at this point, I'd recommend not buying Apple above $600 going into earnings, just based on recent activity in the name.

If you want to trade options, my only recommendation is buying deep in the money calls. They will allow you to take advantage of any upside in the name, but won't force you to put down as much total capital in the name. For example, you could potentially buy Apple weekly $500 calls for about $75. This would allow you to be effectively long 100 shares of Apple for $7,500, instead of the $57,000 plus you would need to own 100 actual shares. If Apple declines, you would lose more in percentage terms, but you only have $7,500 at risk instead of $57,000 (for 100 shares).

In conclusion, I expect another very good quarter for Apple, but don't think that we'll see number quite like last quarter's. The quarter was a week shorter, and it wasn't a holiday one. Expect good product numbers, and some margin improvement. It should be a fun afternoon on Tuesday, and I eagerly wait for them to report.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.

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Tagged: , Personal Computers, Earnings
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