Apple Earnings Preview: What A Difference A Year Makes

| About: Apple Inc. (AAPL)
This article is now exclusive for PRO subscribers.

This time last year the Apple (NASDAQ:AAPL) bears were out for blood: Apple was washed up, the iPad and iPhone fads were over. If you weren't already out of Apple, you were stupid. Microsoft's (NASDAQ:MSFT) Windows 8 was finally going to make tablets useful for real work, and consumers were going to discard their Apple "toys" in droves. And Intel (NASDAQ:INTC) would be rolling out Haswell and Bay Trail processors that would show Apple's home grown mobile processors for what they were, mere hobbies incapable of serious computing. This year, things are so different.

Fewer Bears

To be sure, there are still some Apple bears, but the bear case has become considerably weaker. The Microsoft and Intel threats proved largely empty in 2013, and Apple's demise considerably less imminent.

Microsoft's Windows 8 hasn't exactly galvanized PC sales in the past year, and Windows tablet and phone sales have posted only incremental market share gains. By the end of Q3 2013, Windows Phone had a 3.6% market share vs. 12.1% for iPhone (according to Gartner), an improvement mostly at the expense of Blackberry. Likewise, in tablets, Apple's market share decline, from 40.2% in Q3 2012 to 29.6% in Q3 2013 (according to IDC) was thought mainly due to inroads by Google's Android.

As I pointed out in "Intel's Mobile Money Losers", the perceived threat by Intel tablet processors simply failed to materialize in 2013, as Apple's A7 stole Intel's 64 bit Bay Trail thunder.

Bullish on iPhone, not so Much on iPad

The main stream tech/business media have retreated from the Apple death watch, adopting a more wait and see attitude. This is reflected in analysts' predictions for bell weather iPhone and iPad sales, as summarized by Philip Elmer-Dewitt. In the table below I summarize sales predictions compared to my own:

As can be seen, I'm much more bullish about iPhone sales than the professional analysts, while mostly in agreement on iPad sales. Let me expand on each.

iPhone: There were so many catalysts for robust iPhone growth that I think the analysts are way too conservative. The 64 bit A7 system on chip (SOC) of the iPhone 5s, which Apple's detractors either ignored or denigrated at first, turned out to be huge. It put the power of a 64 bit Intel Bay Trail processor into a smart phone, and consumers responded. At the same time, Apple rolled out the much improved iOS 7, providing much needed features to stay competitive with other mobile OS's.

The iPhone 5s was backordered on the Apple Store for most of Q4. Apple also rolled out the 5s much faster with a simultaneous launch in the U.S., E.U., and China.

Even the 5c was accretive to revenue and unit sales. It was, in effect, a lower cost iPhone 5, and as usual, these marked down previous gen iPhones tend to be popular entry level devices. The 5c also provided low cost access to iOS 7.

iPad: Here, sales weren't so good. iPhone got a running start with a launch late in Q3, but the refreshed iPads had to wait until November, losing a third of the quarter. It's clear the late start was driven by supply constraints of the A7, which the iPad Air and iPad Mini with Retina Display (Mini wRD) shared.

Supply of the Air quickly caught up with demand while the Mini wRD remained backordered on the Store through the end of the quarter. Why? In the past, Apple has provided a graphics-enhanced A series processor for the iPad, such as the A6x. In the past, this was needed for the iPad Retina Display.

This time around, no such enhancement was needed for the A7, so Apple took maximum advantage of economies of scale. But it may have been a marketing blunder not to provide some performance differentiation compared to the iPhone 5s, whereas no one really minded that the Mini wRD and the 5s shared the same processor.

Missing the Mac Pro

I expect Mac sales to be strong for the quarter, at 3.9 million units, essentially flat from a year ago when sales were 4.061 million. Apple had a strong line-up going into the holidays, with all Macs but the Mini having received Haswell upgrades. But the promised Mac Pro was a no-show, with deliveries pushed into February 2014.

Why the delay? Since the U.S. assembly plant is new, production snafus were inevitable, and Apple was just a little optimistic predicting "arrives in December" for the Pro. But the February delivery means that Apple is in full production now and in the process of building up channel inventory. Those of us who have been waiting patiently for the Pro since it was previewed only have to wait a little bit longer, but this hurt sales in Q4.

The Bottom Line

Although I expect Apple to show outstanding growth in iPhone, overall Apple revenue growth will be held back somewhat by its flat iPad and Mac sales, and unexceptional gross margin, as I show in the table below.

Based on the above results, I expect Apple's Q4 performance will have been nothing like the bear expectations of a year ago, when it was assumed that Apple would be in a state of collapse by Q4. However, the meager revenue growth and flat earnings will have the bears howling, "we told you so", and I expect a roughly 5% sell-off after hours. Not the 10% sell-off we saw last year, but not a win for Apple investors. Naturally, I'll be happy to be wrong on this one.

With these results, the reader may wonder how things are so different from last year. Last year, the post-earnings sell off was just the start of a long down-hill slide that saw Apple shares touching the upper 300s by Summer. I expect no such slide this year. To be sure, Apple still has a struggle ahead to fully regain investor confidence.

What must Apple do to get investors excited again? I'll have more to say about this after the earnings call, but basically Apple needs to commit to revenue and market share growth on the order of 10-15% year over year. Apple still faces challenges from its competitors, especially Microsoft and Google, who typically have posted revenue growth in the 10-15% range.

Disclosure: I am long AAPL, . 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.