Analysts Look To Cash Earnings To Get A Grip On Apple

| About: Apple Inc. (AAPL)
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After Apple (NASDAQ:AAPL) crushed estimates Monday night and introduced a forecast for the current quarter that seemed astoundingly ambitious, analysts Tuesday were still trying to figure out whether to take the “guidance” seriously. More important, everyone is trying to get their hands around the pile of deferred revenue — $636 million — that is starting to come from the iPhone, whose sales are recognized ratably over the lifetime a customer holds the phone. The conclusion: start looking at cash earnings rather than traditional income statement earnings.

  • “The big question is whether AAPL is guiding to what it believes it can do or conservatively as usual,” writes American Technology Research’s Shaw Wu, who just last week chided his peers on the Street for being too high in their estimates for Apple’s current quarter, calling those estimates “unrealistic.” “We think it’s somewhere in the middle,” is Wu’s conclusion Tuesday. Wu is raising his price target from $185 to $210. He notes that this is the first time in 8 quarters that Apple has forecast either in line with or above the Street’s estimates. Wu’s raising his own forecasts, of course: In the current quarter, he expects Apple to turn in $9.2 billion in sales and $1.50 in profit on sales of 2.3 million Macs, 24 million iPods, and 2 million iPhones. Interestingly, Wu says that given the rising tide of deferred revenue from products like the iPhone and AppleTV, “cash flow from operations may be a more appropriate way to value Apple” than traditional non-cash earnings per share. His $210 price target is based on a multiple of 26x free cash flow per share of $7.50 next year, plus $17 in cash per share.
  • Bear Stearns’s Andy Neff, raising his price target to $243, says he sees “multiple drivers” for Apple, including the release of the Leopard version of its operating system this Friday, the introduction of the iPhone in Europe next month, the potential for a “3G” version of the iPhone at the Macworld conference in January, and “our thesis that iPhone is emerging as a personal digital lifestyle device.” Neff’s estimates for this quarter are going to $9.4 billion and $1.65, above Apple’s forecast of $9.2 billion and $1.42. Again, like Wu, Neff’s trying to get his hands around the deferred revenue component for Apple. And so he offers an alternative valuation metric: a price-to-operating earnings of 28.5x the calendar year operating EPS of $7.66 “on a cash basis, i.e., assuming iPhone revenues are recognized upfront.”
  • “With 3 major products providing the fuel,” writes Goldman Sachs’s David Bailey Tuesday morning, "Apple should continue to work at least through the holiday season.” The Mac is accelerating, argues Bailey, aided by “increasing international penetration” and broader distribution (Apple said they will have 270 Best Buy (NYSE:BBY) stores selling Macs by the end of the current quarter). Bailey says the rising Macintosh installed base should boost Apple’s sales of the Leopard release to $150 million, 50% ahead of its take for the prior version of the software, which should in turn boost gross margin “over a two-quarter period,” even though Apple Monday night forecast a decline in gross margin this quarter. Like Neff, Bailey is looking for a 3G iPhone to perhaps be unveiled at Macworld in January, potentially another iPod, and perhaps a “sub-notebook” computer of some sort. Bailey’s raising his price target from 190 to a six-month price target of $205. That’s right: he’s retreating from forecasting price appreciation 12 months ahead because, as Bailey puts it, “While we think that Apple could be a good story again in 2008, from these levels the risk is higher as is the likelihood for a pullback.”