Do The Math: Apple's Fiscal 2015 EPS To Rise (At Least) 25%

| About: Apple Inc. (AAPL)

Summary

Evidence is mounting that the new iPhone product purchase mix is going to produce a significantly higher average selling price (ASP) in 2015 compared to 2014.

Informed estimates place the 2015 ASP at $701, up from $597 in 2014.

YoY comparisons on an EPS basis will easily be up 25%-30%, after adding in the effects of volume growth and share buybacks.

Maintaining Apple's modest P/E implies a 25%-30% increase in price, and the growth itself could create an upward market adjustment in the P/E taking the stock into the $150-$160.

The analyst community is well behind the curve in adjusting their price targets, as current consensus is $110, less than 8% growth.

Now that people are actually buying the iPhone 6 and 6 Plus, we are getting a better idea of what kind of product purchase mix Apple (NASDAQ: AAPL) is likely to see. Apple has done a brilliant job structuring the lineup to raise the iPhone average selling price (ASP) for 2015. What will this do to the company's EPS over the course of its launch year? Doing the math on this change shows that current analyst price estimates for Apple stock are significantly low.

What are the relevant changes? First, and obviously, the 6 Plus introduces a higher price tier not previously in the lineup. Secondly, and less expected, Apple's restructuring of its iPhone memory configurations by eliminating the 32 gb iPhone in the flagship models and introducing a 128 gb option, has made the 64 gb upgrade the "sweet spot" for many more people.

The result is a radically revised set of consumer behaviors with respect to product mix and therefore ASP. Anecdotal evidence is in line with this change and so are the wait times associated with the different models, where the longer wait times are for the higher priced models. Though it yields numbers lower than post-launch surveys, let's assume the U.S. split between the "primary" flagship iPhone 6 over the secondary 6 Plus is like the 64% to 26% split seen last year between the 5s/5c. Morgan-Stanley has surveyed the Chinese consumer to obtain the rough mix between the 6 and 6 plus there based on consumer intentions. The result would be as shown below.

Table 1: Consumer Survey Of iPhone Intentions To Buy

US

China

iPhone 6

64.00%

36.00%

iPhone 6+

26.00%

51.00%

Other

10.00%

13.00%

Based on past model sales trends and analysis of consumer intentions, Morgan Stanley's Katy Huberty has estimated the likely 2015 product mix and margins across the full line, from which I have estimated a 2015 ASP of $701. I have checked Huberty's estimates against the precedent of the 2014 product mix, and against various published consumer intention surveys, and they are plausible. Her analysis is below (I have added the pricing information).

Table 2: Derived 2015 iPhone ASP From Estimated Product Mix

Model

Memory

Price

% Of Unit Sales

6+

128

$949.00

4.00%

6+

64

$849.00

10.00%

6+

16

$749.00

11.00%

6

128

$849.00

8.00%

6

64

$749.00

22.00%

6

16

$649.00

25.00%

5s

32

$599.00

3.00%

5s

16

$549.00

7.00%

5c

8

$450.00

10.00%

ASP

$701.60

With this estimated $701.60 ASP in hand, we can compare an expected performance from Apple in the coming year against its performance with the 5s/5c as their flagship models. Performance during the TTM is below. Notice something important, which significantly impacts EPS. Aside from ASP differences, there is also the non-trivial impact of the buybacks. Shares outstanding fell 5% across the last year. They will of course continue to fall across the next twelve months, and the cumulative impact will have an additive effect with other factors on the coming quarterly comparisons over the next twelve months.

Table 3: iPhone contribution to Apple EPS for TTM.

iPhone 5s/5c Intro Year

2013

2014

Q4

Q1

Q2

Q3

Sum TTM

Shares Outstanding (in millions)

6,300.00

6,250.00

6,030.00

6,000.00

Average Selling Price (in millions)

$577.00

$636.00

$596.00

$561.00

Units Sold (in millions)

33.8

51

43.7

35.2

Revenue (in millions)

$19,502.60

$32,436.00

$26,045.20

$19,747.20

$97,731.00

Earnings

$5,168.19

$8,595.54

$6,901.98

$5,233.01

$25,898.72

EPS - iPhone Contribution

$0.82

$1.38

$1.14

$0.87

$4.21

EPS - All Products

$1.19

$2.08

$1.67

$1.29

$6.23

Recent tear downs indicate that gross and net margins for the new phones are similar to past phones, which makes estimating the 2015 comparisons fairly easy.

YoY comparisons will be impacted by four things: 1) ASP change; 2) Unit volume change; 3) Change in shares outstanding; 4) New product category sales. The table below shows my estimate for expected YoY comparisons based on the first three factors (not including sales in new product categories). My assumptions for the 2015 estimate are all kept conservative and are,

  1. iPhone volumes will grow 10% in fiscal 2015 versus 2014. This is a pretty conservative assumption based on initial launch numbers and consumer intention surveys. Multiple reports are that Apple's own estimates are more aggressive. For example, with this assumption the unit volume estimate for Q1 below is 56.1 million units. However, no report has Apple ordering less than 60 million units for Q1. Without being too bullish, one could argue for a more aggressive assumption based simply i) 20% more users in the U.S. are eligible for upgrades this year than last year, and ii) China Mobile has scaled and matured its 4g rollout, but I will not use such (plausible) arguments.

  2. iPhone's net profit margin will stay constant at 26%. This assumption is justified by tear down estimates that gross margins have not changed much.

  3. The pattern of quarter-by-quarter variance in ASPs in 2015 will be the same as in 2014, relative to the overall ASP across the year. This means ASPs will be highest in Q1 and will decrease across the year.

  4. The unit volume sales will vary proportionately the same from quarter-to-quarter in 2015 as in 2014.

  5. Shares outstanding will fall at half the velocity in 2015 than they did in 2014, due to higher per share costs in the buyback. Again, this is conservative since prices have not and will not be double what they were in 2014.

Table 4: Expected iPhone EPS contribution for 2015, with YoY EPS comparison

iPhone 6/6+ Intro Year

2014

2015

Q4

Q1

Q2

Q3

Sum TTM

Shares Outstanding (in millions)

6,000.00

5,900.00

5,850.00

5,800.00

Average Selling Price

$678.08

$747.42

$700.41

$659.28

Units Sold (in millions)

37.18

56.1

48.07

38.72

Revenue (in millions)

$25,211.06

$41,930.10

$33,668.70

$25,527.26

$126,337.11

Earnings

$6,680.93

$11,111.48

$8,922.20

$6,764.72

$33,479.33

iPhone EPS Contribution

$1.11

$1.88

$1.53

$1.17

$5.69

Tot. Estimated EPS w/iPhone 6/6+

$1.48

$2.59

$2.05

$1.58

$7.71

EPS Increase, 2014-2015

124.63%

124.42%

122.79%

122.80%

123.69%

As you can see, the expected EPS increase under these assumptions is about 23.7%, based on the cumulative impact of increased ASP, increased volumes, and decreased outstanding shares. Now let us add in the impact of the Apple Watch. There is no way to know how it will sell yet, so I will estimate it in 5 million unit increments, assuming (again, conservatively) that the watch has net margins in line with Apple's overall corporate margin of 20% and ASP of $450, somewhat above the price of the entry level watch but not dramatically so.

Table 5 Contribution Of Apple Watch to 2015 EPS and YoY Comparisons

Apple Watch 2015

Units Sold (in millions)

5

10

15

20

ASP

450

450

450

450

Revenue (in millions)

2250

4500

6750

9000

Earnings (in millions)

450

900

1350

1800

EPS Contribution

$0.08

$0.15

$0.23

$0.31

Estimated EPS (iPhone+Watch)

$7.78

$7.86

$7.94

$8.02

EPS Increase, 2014-2015 (phone+watch)

124.89%

126.14%

127.39%

128.67%

The result is that even an Apple Watch which sells just 5 million units in year one, which would be considered a disaster, brings the YoY EPS comparison to +25%. At 20 million units, that shoots up to a nearly +29% YoY increase.

But what if iPad sales decrease, especially because of cannibalizing of the iPad Mini by the iPhone 6? Bottom line, it is not going to matter for a few reasons. One, because the iPad Mini is a low margin product that does not contribute much to Apple's earnings to begin with. Second, because the analysis above is ignoring growth in other areas which would offset a dip in Mini sales, such as growth in App store sales, Beats headphone sales, introduction of a 12" iPad, an increase in sales from a revamped Apple TV, Apple Pay and increased accessories sales from items such as Apple Watch bands (which I expect to be high margin and high volume). Compared to all these other areas which are growing, the mini is not that important.

Let me repeat this, so it is not overlooked: Assuming no net growth in other existing product or service categories, and using a conservative assumption of 10% unit volume growth in iPhone sales, the additive impacts of volume growth, growth in ASP and shrinkage in outstanding shares, along with the introduction of a new product category, is going to cause Apple's YoY EPS comparisons to come in at 25% or above (potentially far above). And this is going to be repeated quarter over quarter for the next four quarters.

The bottom line for investors is that neither the market nor analysts have priced this growth in yet. The proof? The current analyst consensus price target for Apple is $110. Yet for Apple to maintain its current, modest 16.3 P/E, given the numbers above, its share price this time next year would need to be at $127. And that's for the scenario where the Apple Watch flops. In a scenario where Apple sells 20 million watches, the share price would need to be at $131 just to maintain its current P/E.

But here's a question investors should be seriously considering. Why should a company with 25% EPS growth and a growing cash balance on its fortress balance sheet not be trading at more of a premium to the historic S&P 500 multiple of 15? As quarter after quarter of 25%+ growth is recorded, it is going to be increasingly difficult to maintain the perception that Apple does not deserve some kind of meaningful growth premium. If market participants were to expand Apple's P/E from 16 to 20, a number which is far from implausible, the share price numbers above would be $156 and $160. Can anyone find me another mega cap stock for whom there is such a plausible case for 50% to 60% price appreciation in the next 12 mos?

Disclosure: The author is long AAPL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author owns Jan. 2015 and Jan. 2016 AAPL LEAPS.

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