On October 25, Apple (AAPL) will lead a conference call to present financial results for its fourth fiscal quarter. By chronological definition, this Q4 2012 report will also lead into analysis for Apple's prior fiscal year, in its entirety. For Apple, the iPhone remains the centerpiece of a horizontally integrated consumer electronics ecosystem. Last month, on September 21, the iPhone 5 launched amid the media hype, winding storefront queues, and a nightclub atmosphere that have become standard procedure at Apple. With the smoke clearing, Apple reported first weekend sales of more than 5 million iPhone 5 units.
Wall Street, however, was not impressed. Prior to launch, whisper numbers demanded initial iPhone 5 unit sales between six million and ten million. Over the past month, Apple shares have declined sharply from $700 to $625, in lockstep with the perceived iPhone 5 sales shortfall. Despite this recent trend, overzealous Apple analysts and short-term traders remain hell bent upon setting themselves up for Q4 earnings disappointment and realized losses. Conservative, long-term investors, however, can exploit regular price corrections to load up on Apple stock. At worst, Apple is transitioning into the mature stage of this Web 2.0 business cycle. As a beta stock, Apple would closely track the S&P 500 Index and make regular dividend payments.
Apple's Leverage Above SmarPhone Market
Apple, alongside Google and Samsung, represent the primary constituents of an oligarchy that dominates the smartphone market. Recent comScore data indicates that Google (GOOG) Android and Apple iOS operating systems power respective 53% and 34% shares of the smartphone market. Beneath this duopoly, Research in Motion (RIMM) Blackberry, Microsoft (MSFT) Windows, and Nokia (NOK) Symbian operating systems desperately claw over the remaining 13% of smartphone subscribers. For the last calendar quarter, comScore estimates that Google Android and Apple are still growing in strength, as evidenced by their collective 4.1% increase in share above the prior quarter. On the handset side of the ledger, Samsung and Apple are first and third, respectively.
Zack Whittaker and ZD Net describe Apple's control over its component parts as "paranoia." This strategic integration of both hardware and software are what power Silicon Valley's latest financial juggernaut at Cupertino. For its latest third fiscal quarterly period ended June 30, Apple reports 26 million iPhone unit sales. In dollar terms, iPhone related activity accounts for $16 billion of Apple's $35 billion in Q3 2012 total net sales. Financially, Apple's iPhone performance is a 20% improvement above the year-over-year period. Today, Steve Jobs' halo effect radiates out from the iPhone centerpiece to include Apple's iPod, iTunes, iPad, and iMac platforms. In Wall Street terminology, this halo effect is worth several billions of dollars in goodwill and intangible assets.
Like clockwork, the competition has intensified efforts to effectively take a bite out of Apple's ecosystem profits. With Samsung effectively serving as proxy for Google, Apple courtroom brawls highlight the steady commoditization of smartphones and consumer electronics in the aggregate. On August 24, U.S. District Court Judge Lucy Koh ruled Samsung guilty of patent infringement charges and ordered the company to pay $1.05 billion in damages to Apple. The very next week, a Japanese jury ruled Samsung innocent of these very same charges. In retaliation, Samsung has added the iPhone 5 onto countersuit claims of its own against Apple. The premium Galaxy SIII phone would be effectively banned from the U.S. market, if Samsung were to lose this appeal.
Google's recent earnings miss highlight the Pyrrhic nature of its very own Android software. Last year, Google closed on a $12.5 billion deal to acquire Motorola largely to secure patents and proactively defend its Android Empire against litigation. Despite these costs, Google still gives away this operating system for free, in order to establish a smartphone beachhead for Search technologies. Critics, such as Horace Deidu and Kevin Tofel, calculate that Google's share of Android profits are shockingly insignificant, relative to the investment.
By all accounts, Apple remains in the smartphone driver's seat.
The Apple iPhone 5 Supply Chain
According to Tim Cook, CEO, Apple sold out of its initial iPhone 5 supply amid its first weekend launch. For Apple enthusiasts, iPhone 5 supply chain bottlenecks bring back memories of Steve Jobs, who seemingly reveled in shortages that reinforced outsized demand and pricing power. Stories alleging Apple factory worker riots in China alongside technical glitches within Sharp's glass screen manufacturing process remain in stark contrast juxtaposed against Tim Cook's background as an operations man. Despite iPhone 5 supply chain shortages, smartphone competitors are not engineering superior technical specifications neither are they showcasing enough marketing savvy to pick up the slack and steal share. On September 5, Nokia hosted a demonstration for its new Lumia 920 Windows 8 phone in New York City. That very same day, traders hastily sold off Nokia stock towards a 15% loss.
Apple's staggered iPhone 5 release scheduling further complicates efforts to gauge financial performance. On September 21, Apple set up shop to launch the iPhone 5 in the United States, Hong Kong, Singapore, Japan, Canada, Australia, Germany, France and the United Kingdom. By the end of the year, the iPhone 5 will be available in more than 100 other countries. Apple's iPhone 5 related profits will not realize full potential until the first quarter of Apple's fiscal 2013.
The Bottom Line
Last quarter, a CNN Money poll of 63 Apple analysts predicted Q3 2012 earnings per share of $11.31 on sales of $39 billion for this company. In actuality, Apple was to report $9.42 EPS on $35 billion revenue for its third fiscal quarterly period ended June 30. During this July 24 earnings call, Apple shares promptly declined from $600 to $575. Peter Oppenheimer, CFO, quickly circled the wagons to dismiss this earnings miss as the consequence of speculation. Apparently, consumers were holding off on third quarter purchases, in anticipation of the then looming iPhone 5 release. Partly in response to Oppenheimer's guidance, Apple shares were to rebound sharply from $525 to $705, before breaking down to today's $615.
This time around, Wall Street will expect no less than fourth quarter $10 EPS on $37 billion in revenue out of Apple. These financials would calculate out to at least $9.5 billion in Q4 2012 net income. I, however, am forecasting weaker performance, where Apple takes down $9 in fourth quarter earnings per share, or 8.4 billion in net income, on $33.3 billion in revenue. For the year, Apple would then post an impressive $42 billion in 2012 net income, which is a strong 62% advance over last year. Like clockwork, however, Apple shares will decline sharply when quarterly corporate earnings fail to meet Wall Street's outrageous expectations. Long-term Apple investors may exploit this looming correction to pick up stock on the cheap.
Despite averaging more than 60% net income growth over the past five years, Apple shares at $615 still trade for less than fifteen times trailing earnings. For the year, Apple will close out its books with more than $117 billion in cash and investment securities, over top less than $51 billion in total debt on the balance sheet. After paying off all debt, Apple would still operate with $66 billion, or $72 per share, in net liquidity. In terms of snapshot financials alone, Apple stock offers solid value.
Going forward, I project that Apple will sell between 100 million and 150 million iPhone units over the next year. For Apple's fiscal 2013, this performance would generate $95 billion in revenue, which should then trickled down to $25 billion in net income courtesy of the iPhone platform. Apple is still likely to report $50 billion in total 2013 net income, if iPad annual sales growth were to decelerate to 50%. Apple may then trade as a $750 billion corporation, with a price to earnings multiple of fifteen. Apple's $750 billion market capitalization above 929 million shares outstanding converts to a one-year price target at $800. If Apple sputters, income investors can collect upon a 1.75% dividend yield at minimum until share price appreciation resumes.
For Apple shareholders, "weak" iPhone 5 sales and "weak" quarterly earnings are a buying opportunity.
Disclosure: I am long AAPL.