January 22, 2013 (5:00 pm)
We pulled an old article off the shelf. We wrote this note in our trading journal just days before Apple reported 4Q2012 earnings in late October. It’s important to remember that the channel “unfill” (as we’ll call it) that occurred as Apple was preparing to introduce the new iPad in October needs to be refilled. That very likely happened during the holiday quarter.
“While many independent analysts have been forecasting sales of roughly 20 million iPads this quarter, Tim Cook came out on stage today and gave a not-so-subtle hint that those estimates were way too high. In essence, he previewed to the Street that sales will be closer to 15 million iPads. So where did those 5 million iPads go? It wasn’t likely a complete lack of demand. Instead, it has more to do with “channel fill”. Apple not only sells products directly to consumers. They also sell to resellers (Walmart, Amazon, Best Buy, Radio Shack, AT&T, Verizon, etc.). Apple’s management has discussed on several occasions that they target 4-6 weeks worth of inventory in the channel. That’s their sweet spot for supply/demand balance. Let’s take the conservative approach and assume that you wipe out 4 weeks of inventory that otherwise would have been in the channel. The company sold 16 million iPads last quarter, which spanned 13 weeks. This is approximately 1.25 million per week. Those 4 weeks of selling 1.25 million iPads into the channel equates to exactly 5 million iPads. So what happened exactly?
Apple chose to silently refresh the iPad with a brand new 4th generation product. This was totally unexpected and analysts had not accounted for it. Apple’s management knew that they were going to replace the third generation iPad and, therefore, did not fill the channel with the older generation model – hence 4 weeks of inventory that otherwise would have been sold into the channel, instead simply disappeared. Since the new model went on sale immediately after the announcement, they can’t sell the older generation for the same price. So they chose to simply draw down the inventory, which analysts could not have modeled into their analyses. The shares dove $20 during the day as investors saw this steep decline in sales. If management is able to explain that this lack of channel filling was in fact the cause, shares should rally (as long as iPhone sales don’t disappoint, which we’ll have a better view on after AT&T releases earnings).
The company refreshed their entire product lineup in the past few weeks. Any way you cut it, they’re going to have monster sales during the December (Holidays) and March (Chinese New Year) quarters.”
Refilling the Channel. Those 5 million iPads that should have been in the channel will need to be replaced. Apple simply shifted 5 million sales from the September quarter into the December quarter. We wouldn’t be surprised if readers responded “but there may not have been demand in the September quarter.” That’s not what channel fill is. Think about it this way. Walmart wants to have 4-6 weeks of inventory on hand at any given time. What Apple did as it ended the September quarter was to draw that inventory down to a matter of days. Now Walmart needs 4-6 additional weeks of inventory (along with any and all sales it made last quarter) just to get back into supply/demand balance. They want to end the quarter with those additional units. So along with all the units being shipped and sold to end customers, each of the Apple resellers needs to re-establish multiple weeks of inventory.
Blowout? It looks like we’re going to start next quarter (Thursday morning) at an extremely low PE multiple – just as we did last January, except at a much more extreme level. And it’s becoming increasingly clear that this will be by far the largest quarter of sales the company has ever seen. It would not surprise us to see a massive beat on both the top and bottom line’s tomorrow.