Apple's Post-Earnings Weakness May Extend To Its Suppliers

by: Zvi Bar

On Wednesday, January 23, Apple (NASDAQ:AAPL) plunged about ten percent after hours, after reporting the company's slowest profit growth since 2003 and its mildest revenue increase in over three years. Increased costs and hastening competition have made Apple incapable of maintaining its prior rate of revenue expansion, and though the company earned more than its guidance or average analyst expectations, the market is punnishing shares in Apple.

The market may now extend that punnishment to its supply chain, which would be guilty of dissapointment by association. Moreover, on January 24, Microsoft (NASDAQ:MSFT) is scheduled to report is earnings for the prior quarter. If Microsoft disappoints, following the frustration evident from Apple's report, it could easily trigger a significant sell-off that could extend throughout the technology sector.

Apple's profit rose less than one percent to $13.1 billion or $13.81 per share for the holiday quarter that was Apple's first quarter of fiscal 2013, or calendar Q4 of 2012. The tech giant's sales increased by 18 percent to $54.5 billion, beating its own guidance by $2.5 billion, but narrowly missing average Wall Street estimates for $54.7 billion. Analysts had, on average, predicted profit of $13.42 per share, so though the company failed to meet sales expectations, it was more profitable than expected.

The company previously provided guidance that it expected its revenue to come in around $52 billion and diluted earnings would be roughly $11 billion or about $11.75 per share. Apple's gross margin for the quarter was 38.6 percent, compared to 44.7 percent in the same quarter last year, 40 percent during the prior quarter and Apple's guidance of 36 percent.

Despite the poor reception that this report received from the after hours market, Apple had record revenue during the quarter, as well as record sales for its iPhone and iPad mobile devices. Nonetheless, the market was expecting such record sales, and the concern is rising that the company will be unable to maintain a competitive advantage over Google (NASDAQ:GOOG) Android OS-based phones, or that the cost of maintaining a competitive advantage will eat away Apple's margins. Moreover, the market is still yet to conclude whether Apple's management actually has the capability to keep producing hit products after the death of co-founder Steve Jobs.

The quarter was an active one for Apple. It included the release of Apple's iPad mini, while its iPhone 5 was launched just before the start of the quarter. The company also released multiple new versions of some of its hardware, including a MacBook Pro laptop with a Retina Display, a revised iMac desktop and the iPad Mini. On December 4, Apple launched the availability of its iTunes store in Russia, Turkey, India, South Africa and 52 additional countries, making the online retail site available in 119 countries. Apple also released the iPhone 5 in China on December 14. Nonetheless, many have complained that these products are not as innovative as prior Apple updates, and that the mapping problems with the iPhone 5 was an indication that the company was hastily releasing products rather than waiting to get them right.

For Apple's fiscal second quarter of 2013, or this current quarter, Apple provided guidance that forecast revenue falling between $41 billion and $43 billion. This guidance is less than Wall Street estimates for revenue of $45.5 billion, but the reality is that Apple generally underestimates its guidance and analysts generally have higher expectations. This time, though, Chief Financial Officer Peter Oppenheimer indicated on Apple's post earnings release conference call that the company's guidance is not as conservative as usual and that Apple expects to report results within its stated range.

Apple also indicated that competition was less of a sales barrier than was Apple's manufacturing capacity, that sales of iPhone 5 and iPad mini devices were constrained by those capacity limitations and that sales would have otherwise been greater. Also, Apple's sales within China grew 67 percent to $6.8 billion, with iPhone sales more than doubling in China, even though the company is yet to execute a contract with China Mobile (NYSE:CHL), the nation's largest mobile carrier. Many anticipate that a deal between Apple and China Mobile could be reached this year.

Be that as it may, Apple may now be at a tipping point where it has simply become too massive to experience the same type of accelerated growth that the company went through following the introduction of the iPhone, expanding upon its prior iPod success by subsequently flipping the mobile phone industry on its head. Since then, other companies and most notably Samsung produced similar smartphones that are, relatively speaking, more competitive with iPhones than any product was at competing with iPods. Many of these companies have also introduced capabilities that the iPhone does not have, including flash compatibility as well as both mini-USB and memory-card ports. Some competition has also begun to aggressively price smartphones, which could put pressure on both Apple and Samsung, which continue to dominate the higher end of the smartphone market.

A few weeks ago, rumors swirled that Apple might soon release a lower priced model of the iPhone, but Tim Cook indicated that Apple sells older iPhone models at reduced prices, which is essentially the same thing and already in place. Moreover, Cook indicated that its iPhone 4 continues to be in strong demand and sold out throughout the quarter. This does appear to be true, as on Tuesday, January 22, Verizon Communications (NYSE:VZ) reported its earnings and the company noted that it activated 6.2 million iPhones during its Q4, or about two-thirds of the 9.8 million smartphones it activated in total for the quarter, and that about half of those iPhones were the newest model. This also means that, at least within Verizon, Apple's older model iPhones sold about as well as all models of Android smartphones did for the carrier.

Within the quarter, Apple's most significant source of revenue and profit was the iPhone, with the company selling 47.8 million iPhones. The company also sold 22.9 million iPads. Apple sold 12.7 million iPods, which beat expectations by over a million units, as iPods continued to be a popular holiday gift. Apple sold 4.1 million Macs during the quarter, including the updated version of the iMac that became available in the middle of the quarter, which was below analyst expectations by about one million units. Some of the miss may have been due to the manufacturing capacity limitations that the company noted, but smartphone and tablet cannibalization of the personal computing market is also likely responsible for some of the miss.

Beyond the immediate hit that Apple took from this report, many of the company's suppliers may also suffer in its wake. If Apple is making and/or selling fewer phones than it could or than is expected of it, then its component suppliers are also selling less components. It should be expected that many of these companies will realize some declines following this report.

One other point to note about Apple's report was that the company went into calendar 2013 holding onto $137.1 billion in cash. This works out to be about 28 percent of the market value of Apple prior to its reporting, and nearing one-third of its post-reporting valuation. Oppenheimer noted that Apple would give back $45 billion to investors over the next three years through dividends and share buybacks, with that sum roughly equaling the amount of this cash that is not held overseas.

It is entirely possible that Apple will announce a dividend increase or share repurchase expansion within 2013. Last week, Apple announced that it hired Luca Maestri, the current Chief Financial Officer at Xerox (NYSE:XRX) as Apple's new corporate controller. Maestri joined XRX in 2011 and the company subsequently began to aggressively buy back shares, repurchasing about $1 billion. Xerox also indicated it will further expand that plan in 2013 and that it shall raise its dividend this quarter. These actions made analyst Ben Reitzes of Barclays comment that "Maestri is a champion of shareholder return.

There are numerous component suppliers for the iPhone, but some of the better known companies include Sony (NYSE:SNE), which makes the 3.8V - 5.45Wh battery for the iPhone 5, as well as the image sensor for its camera, and touchscreen components made by both Texas Instruments (NYSE:TXN) and Broadcom (BRCM). The iPhone 5 is powered by the A6 chip that Apple based on the ARMv7 set by ARM Holdings (NASDAQ:ARMH), and which is made by its largest smartphone competitor, Samsung (OTC:SSNLF). The phone also includes a PM8018 RF power management IC and MDM9615M LTE modem by Qualcomm (NASDAQ:QCOM), an Audio chip made by Cirrus Logic (NASDAQ:CRUS).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.