It's often said that when people get involved into the market, animal spirits are invariably awakened. I have a really hard time controlling my inner bull, the one who made me publish sinfully outlandish numbers last quarter (hey-I have to blame someone else, right?). My predictions turned out so wrong that many Wall Street analysts were closer to the actual results. And that is one great shame for an independent Apple (AAPL) analyst. So, if you feel there are some bullish touches in my numbers here and there, you know who the culprit is. This time, I have taken a few steps to keep the beast in check.
Most of the time, I've been following the rules explained in my previous article on Apple's earnings: using confidence intervals for unit sales, ASPs, other revenue, gross margin, expenses and tax rates, following y/y and sequential trends, using Apple's own guidance and so on (while this article should be self-contained, the reader who wants all the details is encouraged to check my previous article). I have tried to allow for lower results unless there is a real reason to do otherwise when choosing my confidence intervals, but I have also decided to take the bull by the horns: instead of using the middle of the interval as my prediction, I have put 60% weight towards the bearish end 40% on the bullish one.
That's one of the lessons I have learned from my previous errors. It is much more likely for Apple to have a blowup quarter for some of its items (iPad numbers, for example) than a disastrous one out of the blue. As I want to catch most outcomes into the confidence intervals, this phenomenon would mechanically push up the average, that is, my prediction. Let's check out the numbers.
Desktop units and ASP linear charts with trend-lines.
Desktops. Despite the availability of new processors from Intel, Apple did not upgrade their main desktop line, the iMac and the Mac mini. As shown in the graph below, upgrades seem to bring small sparks to unit sales. There was a small upgrade to the Mac Pro, but after some online protests concerning the inconsequential improvements, Apple removed the "New" moniker from its online store and assured everyone a real upgrade is in the works. Apple began its back to school promotion on June 11.
The absence of upgrades and the promotion should have little influence on unit sales, most likely canceling each other out. With no clear sequential pattern, my confidence interval is 1.1M to 1.32M units with ASP in the interval $1250 to $1370, guided mostly by the long-term trend.
Laptop units and ASP linear charts with trend-lines.
(click to enlarge)
Laptops. Apple not only brought upgrades to its very popular MacBook Pro and Air lines, but also introduced a new line of Pro machines, an offspring of those preceding two and of the latest iPad: very thin and powerful, boasting a retina screen that's 75% less reflective than previous versions, helped by hefty graphics chips. Obviously, all that comes for a hefty price. The top-of-the-line version can set you back nearly three grand. As with every new product nowadays, Apple has a backlog of 3-4 weeks on this laptop line.
Helped by these upgrades but also by traditional favorable sequential trends, I believe we will notice an uptick in unit sales: somewhere in the 3M to 3.8M range. The new line of Pro laptops may also have a favorable influence on the ASP that should be in the $1220 to $1340 range.
iPod units and ASP linear charts with trend-lines.
iPod. The iPod is an endangered species, and its only source of new blood is the iPod touch, the phone-less iPhone (the gateway drug to the App store as some like to characterize it). I have no special insight about its evolution during the quarter and there was no news to influence my opinion. I will therefore follow its well established trends for unit sales, and predict 6.5M to 8M units. The ASP should increase slightly from the lowest point in recent years, due to slowly increasing mix of the higher price iPod touch, and should be in the $150 to $170 range.
iPhone units (logarithmic) and ASP (linear) charts with trend-lines.
(click to enlarge)
iPhone. The iPhone remains the workhorse of Apple's business, representing 57.9% of total revenue last quarter and just over half of revenue for the previous four quarters. It also has the highest gross margins among Apple's main product lines and continues to grow exponentially in the long term, as the logarithmic unit sales graph attests. Paying attention to details, however, one observes that Q1-Q2-Q3 was a sustained uptrend in 2011, while this year we have already observed a sequential decline from Q1 to Q2 (still a 2% gain per week in Q2, as Q1 was unusually 14 weeks long).
Apple has explained that the ramp-up of both production and distribution this year was much faster than one year ago. They are in supply-demand balance and have increased the channel inventory by 2.6M units last quarter. All those reasons point to lower sales this quarter as sales have shifted to earlier quarters. However, there is one aspect of the story that would suggest a sequential improvement: iPhone 4S is only nine months old while iPhone 4 was thirteen months old exactly one year ago. My unit sales estimate for this quarter is somewhere (more precisely at 40%) in the range of 14.5% sequential decline to 5.5% sequential growth, while the ASP should not change much.
iPad units (logarithmic) and ASP (linear) charts with trend-lines.
(click to enlarge)
iPad. The iPad is the real story this quarter. Not because it will sell more than the iPhone, but because it is younger, less understood, grew much faster than its cousin, the post-PC era poster-child, the iPhone, and because it drives competitors nuts. Palm, RIM, Motorola (MMI), Nokia (NOK) and many others are old news by now. The fact that nobody acknowledges is that Dell (DELL), HP (HPQ), Acer, and the mighty Microsoft (MSFT) (don't laugh, your reaction would have been considered crazy just a few short years ago) are heading in the same direction.
In their earnings call last quarter, Apple was uncharacteristically bullish on the iPad sales short term. Not only were they able to ramp up production for the new iPad very quickly, but the demand stayed strong. In fact, the new iPad was not in stock in their online store before June 1. Also, what may seem like a marketing detail may just turn out to be a tidal wave: the cheaper iPad 2. If the cited report is true and up to 41% of iPads sold this quarter are the older version, we may just have a surprise monster quarter. As of mid-July, four of its six versions are not in stock in the online Chinese store. I have a hard time thinking of another reason for that other than huge demand. This thing has been in production for 16 months already-and if the ramp-up of the new iPad's production was so successful, how could they stumble on the production of this model?
All things taken into account, I may sin again in being too bullish, but at least I'm not the only one. The iPad 2 story just forces my hand to predict a floor of 21M units sold, with an upper limit of 27M units, which, I know, may seem again foolishly high. As the cheaper iPad 2 should represent a healthy percentage of sales, I predict that the ASP will continue its downtrend and cross the $550 line.
Gross margin. Last quarter's GM was at a record high of 47.4% on guidance of 42%. For this quarter, both the guidance and my expectations are lower, mainly because of a different product mix, but also some favorable conditions during Q2 that may not reoccur (I'm almost paraphrasing Peter Oppenheimer here). The new iPad is definitely more expensive to produce and the iPad 2, now 20% cheaper, a hit to GM almost surely. When I add better Mac sales and the new line of laptops with Retina display to the equation, my crystal ball tells me that GM should be somewhere in the 42.5% and 47% range.
I won't bore my readers with detailed predictions of other revenue like software and iTunes or operating costs, as most of them are based on y/y and sequential trends and have less impact on the final EPS number. I summarize all that in the following table.
Further remarks. I would again warn my readers to be cautious with bets on AAPL around earnings. While we may see a spike if my prediction comes true, there's no reason that it may not go back to 12 P/E in the short term (be it just profit taking or deeper reasons of concern like Europe's finances), which would mean just a bit above $550. The good news will catch bearish investors and analysts unprepared. The aborted rally after the previous earnings call may be restarted and has a chance to carry the stock price to new highs during the following months.
So, what do you think? Have I managed to master the bull, or is he still rubbing my face in the mud? Please let me know in the comments section.
Acknowledgment. I would like to thank John Markuson for his help with English grammar and style for this article.
Disclosure: I am long AAPL.
Additional disclosure: I leverage my investment with call options.