Time flies when you're having fun. Believe it or not, we are just days away from the end of the third quarter. Yes, that means earnings season is a few weeks away. Today, I'm here to discuss what everyone will be looking forward to: Apple's (AAPL) Q4 results. This will not be my official earnings preview. However, I am going to provide both a bull and bear case, in an effort to present a baseline of expectations going into this report. That way I can show the issues at hand, while also showing a balance (a bad quarter, a good quarter). Before you continue with the rest of this article, I urge you to also glance at my related Apple articles on this quarter first.
- The Apple iPhone Frenzy is Here - Discusses the iPhone 5 launch and how to estimate iPhone sales for the quarter.
- Apple's Q4 Depends on iPhone Release - Earlier in the quarter preview showing why iPhone launch during Q4 was so important to this quarter's results.
Now that the iPhone 5 is officially out, we can use that to estimate what Apple will do this quarter. So let's get into a couple of scenarios. First, I'll give a bear scenario. This is close to a worst-case scenario for Apple. Second, I'll give what I believe to be a best case scenario. I'll then discuss some analyst expectations. Remember, my formal Apple earnings preview will be right before earnings. I still have some numbers to crunch before then, but this will at least give a mini preview into some of the trends I am expecting.
The bear case:
Like I said, this is most likely a worst case scenario for the quarter. The worst case scenario first starts by showing that there is an industry wide slowdown in computer sales. Despite a Mac refresh in June, Apple actually has a year over year decline in total Mac sales from 4.89 million to 4.75 million. Also, the slowdown in iPod sales is a bit more than some might expect, falling to 5.5 million units from last year's 6.62 million. In both cases, selling prices continue their downward trends.
In terms of the iPad, Apple was able to sell the device for the first time in China during the beginning of this quarter. In fiscal Q3, Apple sold over 17 million iPads, and in the prior year period they sold 11.1 million. In the bear case, Apple sells 14 million iPads. It represents decent growth from last year, but is down from the prior quarter. The introduction in China was not able to offset a natural decline after a strong intro period, and some purchases were held back due to rumors that an iPad mini will be launched in October. Also, increased competition from other tablets, such as the Google (GOOG) Nexus, eat away some of Apple's market share.
As for the iPhone, Apple sells 10 million new iPhones in the first week plus after launch. However, the slowdown in iPhone sales pre-iPhone 5 was much greater than expected, as only 12 million were sold. Apple sells 22 million total iPhones in the quarter, and due to more than half of them being the older unit, the average selling price comes down.
Overall, sales numbers are down, and lower selling prices do have an impact on margins. Also, because iPhone revenues as a percentage of Apple's total are lower than previous quarters, margins take a second hit. For the quarter, Apple generates $31 billion in quarterly revenues. As margins are hit, Apple only produces a net profit margin of 24%, which leaves earnings per share of $7.85. Both numbers are up from last year's period of $28.27 billion in revenues and $7.05 in EPS, but miss both Apple's and street expectations.
The bull case:
In the bull case, Apple reaps the benefits of a full selling quarter for the new Macs. Apple sells a quarterly record 5.4 million Macs, and the average selling price rises from Q3's average as some of the new higher priced models sell well. In terms of the iPod, the sales falloff is not as much as expected, and Apple sells 6 million units.
In this scenario, the iPad sells extremely well in China, and demand in other regions remains strong. Apple sells a record 18 million iPads, although the average selling price dips a little (continuing the trend), but not as fast as previous quarter declines.
In terms of the iPhone, Apple sells 14 million iPhones before the launch. With over 2 million units sold in the first 24 hours, the launch is met with plenty of excitement. Apple sells 14 million iPhones the rest of the quarter, for a total of 28 million. With a higher percent of sales from new phones, the average selling price rises and margins are strong.
In the bull case, Apple comes in at $39.25 billion in quarterly revenues. With selling prices higher, and a larger percentage of total revenues coming from the iPhone, Apple's net profit margin is 25.5%. That leads to earnings per share of $10.56.
Apple / Analyst Expectations:
When Apple reported Q3, it stated that it believed Q4 revenues would be about $34 billion and that earnings per share would be about $7.65.
With the launch of the iPhone, and sales appearing to be very strong initially, analysts have started raising their expectations for the quarter. Currently, analysts are expecting $36.03 billion in revenues and $8.79 in earnings per share. I believe that is a fair number right now.
Some extra considerations:
It appears to be a very strong launch for the new iPhone. The real question is going to be how much of a slowdown was there before the launch. Also, the bull case I presented shows some awfully high estimates for the other three products, and I don't know if personally they can achieve such high results. That being said, even if Apple doesn't reach those elevated numbers, the bull case projects over $39 billion in revenues, with current analyst estimates at $36 billion. There is plenty of wiggle room there.
The problem we could have, and this is always an ongoing issue, is if Apple analysts get too optimistic going into the quarter. We've seen analysts raise their estimates too high in the past, which has caused Apple to miss their expectations, even if they beat their own.
The other thing to consider is the implications of the large amount of iPhones sold on the three carriers, Verizon (VZ), AT&T (T), and Sprint (S). We heard recently that many Sprint stores have been sold out of the new iPhone, but we don't know how many they got to begin with. They could easily have sold out because they got a small number.
According to market researcher comScore, AT&T grabbed nearly two-thirds of online sales for the new phone thanks to a large customer base wanting to upgrade from the iPhone 4. Verizon had roughly a quarter of the sales, with Sprint around 8 percent. However, we saw a similar trend with AT&T leading early sales of the 4S, but after a month of sales Verizon was the leader. In the end, we'll find out once these names start reporting earnings. But remember, millions of iPhone sales will mean lower margins for these names early on, especially in their third quarter reports. These companies will take a hit on selling the phones, but will make it up in future months as the expensive phone and data plans pad the bottom line.
Since the iPhone launch has been tremendous, I continue my recommendation of being long Apple and buying on pullbacks. I started recommending Apple about a year ago at $375, and we have seen an incredible rally since then. I'm not as bullish as some of those analysts that see Apple at $1,500 in roughly 3 years, but Apple is still a name that long term investors will want to own in their portfolio.