Apple's 'Miss' Creates Intriguing Opportunity

| About: Apple Inc. (AAPL)
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Global technology powerhouse Apple (AAPL) reported its fiscal year 2012 third quarter earnings early last week. Earnings grew "only" 19.6% to $9.32 per share, about $1.04 short of expectations. Revenue was also slightly less than expected, growing 22.6% to $35 billion, short of the consensus estimate of $37.5 billion. Gross margins increased by 110 basis points year-over-year, to 42.8%. However, the company still greatly exceeded its own guidance of $34 billion in revenue and $8.68 per share in earnings-albeit the firm is almost legendary for its guidance "sandbagging." Like other companies with international exposure, the stronger dollar negatively impacted revenue, and the firm expects a negative impact of approximately $400 million in its fourth quarter. Management guided to fiscal year 2012 fourth quarter revenue of $34 billion, gross margins of 38.5% and earnings per share of $7.65. Though the sell-side may have burdened Apple with unrealistic expectations, we think shares are undervalued. Please click here for our valuation report on the firm.

Due to its limited product lines, Apple provides detailed product sales information that is extremely helpful. On the other hand, this has led to analysts forecasting iPhone, iPad and Mac sales, creating an entire new set of expectations for the company to meet. As a result, unit numbers have become almost as important for some analysts as the traditional measures like earnings and revenue.

"Disappointing" iPhone numbers seem to be the big concern. iPhone unit sales increased 28% year-over-year to 26 million, but fell 26% sequentially. Though management noted weakness in Europe, it also indicated that sales in the US and China were negatively impacted by macroeconomic headwinds. However, CEO Tim Cook attributed most of the $2.2 billion sequential decline to falling iPhone sales in China largely due to seasonal factors. CFO Peter Oppenheimer also pointed to resource-based economies as regions of weakness going forward. Further, he acknowledged "new product rumors" as negatively impacting iPhone sales.

Though some may not give much credence to this excuse, we've heard of plenty of consumers waiting for the new iPhone before upgrading. Consumers have caught on that Apple is more than due for an iPhone upgrade as the 4S was an incremental upgrade rather than a refresh. Though subscriber activations may be down at Verizon (VZ) and AT&T (T), Sprint (S) users continue to flock to the iPhone as every month marks more and more subscribers eligible for plan renewals and upgrades, in our view. iPhone 5 will be a major catalyst for the company when it is released.

iPad sales were relatively stronger on a year-over-year basis, accelerating 84% to 17 million units. This represented a sequential unit increase of 44%. Though we question whether or not the third iteration of the device will prompt many upgrades in the US, it's crucial to remember that sales of the iPad in China began just a short time ago. Still, numbers suggest that average revenue per unit (ARPU) is falling for the iPad since it isn't subsidized by the major phone carriers like the iPhone. Additionally, iPad growth is aided by education and enterprise customers, likely resulting in bulk sales at slightly lower prices. Even though the iPad may be a larger growth driver in the firm's fiscal fourth quarter, the shift in the revenue mix may cause margins to suffer. Yet, iPad purchases might lead to increased revenue for the iTunes store, compensating for the lower hardware margin.

Like the iPhone, Mac sales seem to be plagued by consumers waiting for the next product release. Mac desktop sales have somewhat languished, as unit sales of the traditional computer fell 13% year-over-year and revenues fell 19%. Portable unit sales increased 8% year-over-year, but revenue grew just 3%. Although the entire traditional computing space has been under pressure, Apple expects its installed enterprise customer base to provide a cushion beneath sales. Mac units in Asia-Pacific fell 4% year-over-year, and virtually every geographic region (except Japan) saw units grow 2-3%. We think the back-to-school season, as well as strong growth of the new MacBook Pro should help the segment recover.

The iPod might be headed toward extinction, but it still provided the company with over $1 billion in sales in the third quarter. iTunes also remains strong, with revenue growing 31% year-over-year to just over $2 billion. It often gets overlooked with so many other high profile businesses, but iTunes is steadily growing along with its hardware counterparts.

Overall, we thought the quarter was fantastic. Not many international companies are growing the top and bottom lines in excess of 20%, especially not companies with sales exceeding $30 billion quarterly. It's easy to get lost in the euphoria of ever-increasing expectations, but we like to look at the big picture. Apple has some exciting product launches in 2012 and still generated over $10.2 billion in operating cash flow during its third quarter. The firm also declared its quarterly dividend of $2.65 per share.

Looking at the company by the numbers rather than on the basis of the earnings "miss" reveals a firm that is still incredibly cheap and has more cash in its coffers than it knows what do to with ($117 billion). Though we're waiting for its technical assessment to improve before adding to our position in our Best Ideas portfolio, we think shares of Apple are very attractive at current levels. We think the company is worth $813 per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: AAPL is included in our Best Ideas portfolio.