April 26, 2013 (1:00 pm)

A few readers have asked us to explain how we achieved our *very preliminary* estimate of Apple LTM (last twelve month) earnings jumping from a trough of ~$39 this upcoming September 2013 to roughly $49 just three quarters later (June 2014). We disclosed these figures in our previous post discussing why earnings growth – or lack thereof – drives price action, which you can see here. Below, we broadly explain some of our underlying assumptions

iPod/Mac Business. iPod and Mac sales have formed fairly predictable sales trends over the years. We adjust ASP’s and unit shipments seasonally based on historical consumer demand, projected product mixes, and widely expected product refreshes. We don’t expect a meaningful change in either of these business lines, nor do we expect much in terms of growth in either category.

iPad Business (Unit Sales). We expect iPad sales to decline sequentially (not year-over-year) over the next two quarters – with estimates of 18mm in June and 15mm in Sept. We expect education sales to support demand through the quarter. We are conservatively modeling introductions of an iPad mini with retina display as well as a new larger iPad with an iPad mini-like body in early October. We expect a boost in sales to ~30mm units in the December quarter, followed by ~25mm in the March quarter (buoyed by Chinese New Year) and ~22.5mm in the June quarter. We believe the most significant year-over-year growth to come from iPad sales in FY2014.

iPad Business (ASP). iPad average selling prices (ASP) have declined from a peak of $667 to the current $450 per unit. Nearly $100 of the decline took place after the release of the mini with a significantly lower price point. Tim Cook noted that iPad mini sales shattered their expectations this quarter, meaning the mix was highly tilted toward the mini. We expect this mix to be relatively constant through FY2013 (i.e. the shift has already taken place, and the ASP is nearing a trough), and for the ASP to remain at $450 for the June and Sept quarters. Once Apple releases a mini-like body for the larger iPad, we expect the mix to shift slightly back towards the larger iPad as it becomes smaller and more mobile and an increase in ASP to the $475 region.

iPhone Business (Unit Sales). We are projecting a sequential decline in iPhone sales to 28mm units for the June quarter. In the year ago quarter, Apple sold 26mm units. Like the March quarter, we expect a beat of at least 2mm units year-over-year due to (a) additional carriers, (b) additional countries, and (c) aggressive pricing and financing in emerging markets. We do expect a slight uptick (again, sequentially) to 30mm units in September, with the assumption that the quarter is “saved” by a late-quarter launch of the new iPhone model, adding 5-8mm units in the last days of the quarter. Our very preliminary estimates for the December and March quarters are 50mm and 45mm units, respectively. While this may seem dramatic, we’ve been reviewing previous launch quarters to get a handle of potential customers. 37mm units were sold in the Dec 2011 quarter, meaning 30+mm customers will be eligible for an upgrade that quarter. Additionally, a combined 37mm units were sold during the June/Sept 2011 quarters – these customers will be eligible earlier, but may very well wait for the new model. While the 50mm and 45mm estimates may seem aggressive, we believe they are closer to the realistic end of the spectrum. Further, 50mm units in Dec 2013 would only represent a 4.5% year-over-year increase in sales.

iPhone Business (ASP). iPhone ASP’s have been in the low- to mid-$600′s for almost the entire history of the product category. The recent slight move down to $613 is due primarily to the higher demand for lower priced models (4 and 4S). We assume continued deceleration in ASP (as the lower priced phones continue to outsell the 5) to $600 through the September quarter. In December, we expect a bump to $625 in order to account for likely higher sales of the new (and higher priced) model.

Margins. This is truly a wild card. We are estimating a 37.0% and 36.5% gross margin for the next two quarters. We expect margins to jump in Dec/March as sales skyrocket (based on estimates above) and the cost per unit slightly declines. However, our estimates do not assume Apple see’s higher than a 39% margin through FY2014 (which we believe is very conservative). Further, Horace Dediu put together a fantastic analysis explaining how the recent change in Chinese warranties affected gross margins by up to 1% this past quarter.

Earnings. The buyback is very important to consider here. Currently, we are estimating a mid-$7.00 and an $8.00 EPS figure for the June and Sept quarters, respectively. That is higher than we previously estimated due primarily to the lower float. Thereafter, in FY2014, we expect to see fairly easy year-over-year beats in earnings per share in the Dec/Mar/June quarters in the amount of $2, $4 and $4, respectively. This allows us to achieve the trough to peak estimates from ~$39 in September 2013 to ~$49 in June 2014.

We have not yet modeled further than June 2014 due to the lack of transparency into future product releases, which could have a material impact beyond that point. That said, we expect the buyback to have an increasingly large effect on EPS in FY2015 and beyond. The year-over-year comparisons should be easily beat, driving LTM EPS to levels never seen before by this company.

Please share your thoughts.

April 24, 2013 (6:30 pm)

With 20/20 hindsight, the fall of Apple’s share price is easily explained. The stock market is a forward-looking mechanism. And those investors that were looking forward saw how difficult it would be for Apple to achieve year-over-year earnings growth. Margins were impressively high last year. Even with the expected revenue gains, the likeliest scenario was for EPS to drop against previous periods. For those investors that saw this dynamic taking place, it wasn’t difficult to envision the headline “Apple’s earnings declined year-over-year”. At the time, however, we didn’t recognize that dynamic.

Apple’s Year-over-Year EPS (red) and Revenue (blue) Growth vs. Share Price (green)

Stock Declined Ahead of Negative Growth. Looking at the chart above, it’s clear that the market recognized Apple’s growth was not only declining, but actually turning negative. It is often said that the stock market tends to look six months forward. That makes a lot of sense here. The high in mid-September 2012 took place just about six months before a dramatic year-over-year decrease in earnings. While the earnings decline for the December quarter was only $0.07 from the year ago period, the March quarter saw a decline of well over $2.00. And the June quarter is likely to see another $1.50 or so decline compared to the previous year. But we believe that is now priced into the stock in the low $400′s. The real question is where do we go from here?

In our estimation, Apple shares are nearing a turning point. The Spring and early Summer may see choppy price action, as earnings are going to continue to decline year-over-year. We expect the last twelve month (LTM) earnings to decline from the current $41.89 to a trough in the high $39′s during the September (fiscal 4Q2013) quarter. But, again, the market is a forward-looking mechanism. So this will very likely be priced in before we get to that point in time. Once investors can see past the negative growth phase, it will begin to factor in the shift towards positive growth and drive another steep rally.

Apple’s LTM Earnings (blue) vs. Share Price (green)

The shares of Apple topped out months before the earnings growth rate turned negative. We expect the same reaction months before earnings return to positive growth.

Buyback Effect. With the buyback announcement last night, one factor that most analysts have not incorporated into their models is a decreased float (share count). This artificially boosts earnings per share – earnings are what they are (i.e. they remain constant), and share count decreases, driving an increase in EPS. With roughly $58 billion remaining in their buyback “war chest” to be utilized over the coming 32 months, we expect 12 million shares to be repurchased each quarter. This figure conservatively assumes a $450+ share price for the repurchases. This adds (again, conservatively) $0.10 to each quarter’s EPS – and it is cumulative. After ten quarters (2.5 years), this will add about $1.00 to earnings.

Fiscal 2014: Dramatic EPS Growth. And this is precisely why we expect the share price to once again rally hard later this Summer. Starting with the December (1Q14) quarter, we expect Apple to again show earnings growth. Its organic EPS growth will be boosted with the buyback affect and create pretty dramatic growth. And because of its relatively “weak” fiscal 2013 earnings per share figures, the year-over-year comps throughout fiscal 2014 will easily beat on a year-over-year basis and show strong growth. To give you a high-level sense of our estimates, we expect the LTM EPS to surge from the high-$39 level in September to the very high $40′s during the course of fiscal 2014.

Round 2. During the one year period when the LTM EPS jumped from $35 to $44 ($9 per share), the share price rose from $440 to a high of $705. What will happen in the anticipation of LTM EPS once again climbing $9 per share – from $39 to $48 in fiscal 2014?

Let us know how you think this will play out.

April 23, 2013 (7:30 pm)

We compared our estimates (Three28 Est.) to the actual results and management’s guidance. While Apple’s management only provides guidance on a few figures, we derive likely guidance numbers indicated by an asterisk where we’re able to given other information (i.e. revenue guidance + margin guidance to find gross profit, etc.). You can review the earnings preview we provided on March 18 here. Overall, our unit estimates were extremely close to actual figures this quarter.

Mac Business: Our 4 million unit estimate was within 50,000 units of the actual shipments. This was in-line with both the previous quarter (4.06 million units) as well as the year ago quarter (4.02 million units). We expected a boost due to the iMac supply constraints during the previous quarter as well as the price decrease on Macbooks early in the quarter. We’re surprised to see the average selling price (ASP) $150 above our expectations. We decreased our ASP to $1,225 from the previous quarter’s $1,359 due to the MacBook Pro price reduction mid-quarter and availability of the lower-cost iMac’s. Clearly this thesis was incorrect. We’ll continue to research this dynamic. While our unit estimates were very accurate, ASP’s beat to the upside.

iPod Business. Our 6 million unit estimate was roughly 6% above the actual figures. The year ago quarter saw a roughly 50% drop (to 7.7 million units) in iPod sales after the holiday quarter (15.4 million units). We assumed the same drop (from 12.7 million units). We slightly decreased ASP compared to the previous quarter to be conservative; however, the product mix remained the same and the ASP rose very slightly. Overall, our estimate was within 3% of actual revenues.

iPhone Business. We estimated 37.5 million iPhones units this quarter, which was within 70,000 units of actual shipments (or a 0.2% discrepancy). Our estimate reflected a 10 million unit decrease compared to the previous quarter and a nominal 7% increase over the past year (35.1 million units). We expected the year over year comp to be easily achieved since the company is selling them in more countries and to more carriers (as well as aggressively marketing in less established markets). We expected the product mix to remain relatively constant over the previous quarter, but it looks like consumers slightly preferred lower cost (and lower margin) models. This explains the decrease in ASP compared to our estimates. Overall, we couldn’t have come any closer on the unit shipments, but must focus on the product mix to better gauge ASP’s going forward.

iPad Business. We estimated 20 million iPad unit sales, which was within half a million unit sales (or roughly 2.5%. This represented a slight decrease over the previous quarter (22.9 million units) and significant jump over the year ago quarter (11.8 million units). We expected the supply constraints of the iPad mini last quarter and the Chinese New Year to begin this quarter to drive demand. We decreased our ASP expectations to $440 in light of the rise of our expectations for the iPad mini. This proved to be a bit too low compared to the actual ASP of $449. Overall, we were within 1% of revenues in the iPad business.

Revenues. Our revenue estimates were light by $0.9bn, primarily due to the higher than expected Mac ASP’s and slightly increased iTunes sales. Our revenue estimate came in 2% light this quarter – just about where we’d hope to be going forward. Since we utilize our estimates in order to project future price performance, we hope to be conservative, but realistic in our expectations.

Gross Margins. We overestimated gross margins by a large degree. We expected margins to improve compared to the previous quarter, since the typical dynamic is for the quarter of a product release to see the lowest margins. With margins expected to be even lower next quarter, it may be a sign that new product will be released toward the end of the quarter (potentially around the June WWDC). However, Tim Cook on the conference call referenced new products coming “this Fall” – not Summer. So we’ll keep our excitement contained for the time being.