Apple Earnings Preview (2Q 2013)

March 18, 2013 (6:15 pm)

With shares of Apple finally catching a bid in the market, now seems to be as good a time as any to release our fiscal 2Q 2013 earnings estimates. Remember, Apple’s fiscal quarter does not match the calendar quarter. Its second quarter is actually the January-March time frame.

We overestimated last quarter’s earnings by $1.60. We provided a review of our estimates compared to the actual figures after Apple released earnings. We are a bit more conservative here due to our overly aggressive expectations last quarter as well as the additional guidance offered by Apple management. Interestingly, we estimated unit sales and average sales prices before attempting to review total revenues and happened to fall right in-line with Apple’s guidance.

 AAPL 2Q13 Earnings

Mac. We’re estimating 4 million Mac unit sales this quarter. That is roughly in-line with both the previous quarter (4.06 million units) as well as the year ago quarter (4.02 million units). We are confident that Apple can achieve this estimate for a number of reasons. First, Apple reduced the price of the MacBook Pro’s mid-quarter. After speaking with several Apple salespeople, this price reduction has driven increased demand for the laptop. Second, the iMac was severely constrained last quarter. That supply constraint has since been relieved, with the computer now shipping in a matter of days (if not hours). Not only was Apple able to take care of the significant back log of orders, but they are now able to sell on-demand. Further, since supply was constrained last quarter, Apple will need to fill the channel with its usual 4-6 weeks of supply. Lastly, a majority of educators purchase in the March time frame for the following school year. Apple released a new, lower cost iMac only for the education space. We decreased our average selling price (ASP) to $1,225 from the previous quarter’s $1,359. This was primarily driven by the price reduction mid-quarter in the Retina display MacBook Pro’s as well as the availability of the lower-cost iMacs.

iPod. We modeled 6 million iPod unit sales. 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’re modeling the same drop here (from 12.7 million units). Additionally, recent reports suggest a 17% drop year over year, which implies roughly 6.4 million units. We’re taking the conservative approach here with an estimate that is roughly half a million units below those reports. Further, while the product mix is the same as the holiday quarter, we’re decreasing our ASPs to $165 from the previous quarter’s $169.

iPhone. We are modeling 37.5 million iPhone unit sales. This reflects a decrease in over 10 million units from the previous quarter (47.8 million units) and a nominal 7% increase over the year ago quarter (35.1 million units). We believe the year over year comp will easily be achieved, as the company is now (1) selling the device on many more carriers, (2) selling the device in additional countries, and (3) aggressively marketing the device in less established markets, such as southeast Asia and India. Further, the iPhone can now be purchased for as low as $0.99 in many cases. We are modeling ASP’s on par with the previous quarter, since the line-up remains exactly the same as that quarter and we expect the sales mix between versions to be roughly consistent with that quarter.

iPad. We are estimating 20 million iPad unit sales this quarter. This represents a slight decrease over the previous quarter (22.9 million units) and significant jump over the year ago quarter (11.8 million units). First, Apple faced supply constraints last quarter around the iPad mini. Since we expect roughly equal sales between the mini and its larger sibling, the company’s ability to meet demand is crucial. Those constraints are now lifted. The Chinese New Year also proved to be a significant driver of iPad demand last year, and a number of reports out of Asia indicate that the device was the “go to” gift for that holiday. Third, as we mentioned under the Mac explanation, educators tend to purchase technology and equipment for the following school year around the March time frame. A number of schools have successfully integrated the iPad into their curriculum and we expect this to continue (and significantly expand in the future). We believe our iPad estimates will prove to be conservative in light of these drivers. We are decreasing our ASP expectations to $440 from $467 during the previous quarter (and $559 during the year ago quarter). This is due in large part to the shift toward the iPad mini from its larger sibling.

iTunes, Software and Peripherals. Apple changed the way it reports software and accessories last quarter. Taken together, we expect roughly $4 billion in revenues from these categories (down from $5.5 billion during the holiday quarter, and up from the $3.6 billion in the year ago quarter). Historically, sales of some software and peripherals were allocated to specific product lines. Apple is now separating those out into these new categories. Disregard the breakout between the $2.5bn, $1.5bn and the $0. Our model is still organized based on the older product categories.

REVENUES. We are projecting revenues of $42.7 billion, slightly above the mid-point of Apple’s guidance.

GROSS MARGINS. We understand that Apple’s gross margins were significantly depressed last quarter due to the introduction of multiple new products. However, with no new products this quarter, we expect margins to expand slightly. We are estimating roughly 39% margins.

EPS. Apple did not provide EPS guidance this quarter. Instead, we derived the EPS that the company likely would have guided to ($9.73) based on historical precedent. Clearly, Apple did not want to provide guidance that was almost $3.00 below the year ago period. Based on our unit sales, average selling prices and gross margin estimates, we project $10.66 in EPS this quarter. That will decrease LTM earnings to $42.46. At the current price of $455, the PE based on next quarter’s likely earnings figures is 10.7x.

CASH. Cash per share is not something we want to lose track of. We expect Apple to report cash and cash equivalents of almost $150 billion, which represents approximately $158 per share. Again, based on the current $455 share price, its cash balance represents 35% of the share price. That means that 65% of its share value (or $297) is allocated towards the company future earnings. While Wall Street doesn’t look at (or care about) ex-cash valuation, the company will be trading at 6.9x LTM earnings after it reports in four weeks.

CAPITAL ALLOCATION. Apple will address its capital allocation strategy after the meeting of its Board of Directors (which was rumored to be this past weekend) or on its 2Q 2013 earnings call. We wouldn’t be surprised if Apple waited until the latter. Why? First, because it has to issue a statement by then. Look at that cash number we illustrated above. It will have nearly $150 billion in cash and cash equivalents. That is a shocking and unnecessarily enormous number. They need to be able to say “but we’re giving you more now!” and take focus away from the sheer size of the cash balance. Second, because it knows that its EPS will drop significantly year over year. This would be a way to control the story. Instead of headlines reading “Apple EPS drops 20% year over year”, they will read “Apple to buyback $50 billion” or “Apple doubles its dividend payout.”