A lot has been said and written about Apple's Q1 report. My goal at MagicDiligence is to approach earnings reports and price targets from an objective, fundamental, value perspective, instead of from the emotional and breathless direction so many investors and stock market writers use.
So, first, Q1 was hardly a "bad" quarter. Revenue rose 18% as reported, and when adjusted for weeks (last year had an extra week), revenue was up 27%, about in line with the last few quarters. Gross margins dipped to 38.6%, well below Apple's 40%+ numbers for the past 3 years. This should be little surprise - Apple's markets have grown quite crowded, with many competing devices being sold at cost. So maintaining a decent normalized growth in profits isn't too bad. And let's not forget Apple's absurd $137 billion in cash and debt-free balance sheet, because a lot of "investors" ignore it.
All that said, I was disappointed in the quarter. And not for the reasons being popularized in the media. I believe Apple shot itself in the foot by refreshing virtually its entire product line right before the holidays.
First, a quick recap. Apple introduced the iPhone 5 and new iPods in late September. It followed with a massive event in October to introduce new thin iMacs, a 13" Retina Macbook Pro, the iPad 4th gen, and the iPad mini. So virtually all of its product lines had new models ramping up production for the holidays. Tim Cook mentioned on the conference call that Apple was supply constrained on the iPhone 5, iPhone 4 (?!), iPad mini, and new iMacs for virtually the entire quarter. So, by their own admission, they missed a lot of potential sales.
No problem, right, they will just get those sales in Q2? Well, no - that's not how consumer electronics works. When customers are buying a holiday gift, and can't find an iPad mini or iPhone 5, they don't and can't always wait. Instead, they may switch to a Kindle Fire, or trade down to an iPhone 4S or 4. Given Apple's Q2 guidance - which is now supposed to be accurate - year-over-year sales growth is only going to be about 7%. This indicates that the company missed a lot of sales in Q1 that are not coming back.
That's a big concern. Tim Cook made his bones as a highly renowned operations manager. This is what he's supposed to be good at. But we're getting some concerning red flags here. The hire and subsequent firing of former retail head John Browett was an embarrassment (retail same store sales were up only 2% in the quarter, another concern). Cook still hasn't hired a replacement. Firing Scott Forstall was another big risk, but we'll see how that goes. And now some poor planning and execution on new product launches.
All this said, Apple's valuation right now is comical. Its EBIT/EV earnings yield is 18.1%, which is far higher than stagnant, declining competitors like Hewlett-Packard (HPQ, Financial) (16%) or Dell (DELL, Financial) (12%). That's just funny. Also, explain to me again why "investors" love Amazon (AMZN), a company that is barely profitable yet continues to trade at nose-bleed valuations?
Consider also the litany of potential upside catalysts. It has been 3 years since the first iPad - do investors really believe Apple has nothing big up its sleeve within the next few years? The launch timing and supply issues are eminently fixable. Apple began buying back stock for the first time in recent memory last quarter and has a ton of capital to accelerate that program, given the current valuation.
And then there's the fact that iPhone picked up significant market share last quarter...
No, this is not a dying company. It is one going through a bit of a self-inflicted rough patch and increased competition. I'll ding the sell early target a bit, but I still see Apple as an excellent Magic Formula choice at current prices. Our target is $700.
So, first, Q1 was hardly a "bad" quarter. Revenue rose 18% as reported, and when adjusted for weeks (last year had an extra week), revenue was up 27%, about in line with the last few quarters. Gross margins dipped to 38.6%, well below Apple's 40%+ numbers for the past 3 years. This should be little surprise - Apple's markets have grown quite crowded, with many competing devices being sold at cost. So maintaining a decent normalized growth in profits isn't too bad. And let's not forget Apple's absurd $137 billion in cash and debt-free balance sheet, because a lot of "investors" ignore it.
All that said, I was disappointed in the quarter. And not for the reasons being popularized in the media. I believe Apple shot itself in the foot by refreshing virtually its entire product line right before the holidays.
First, a quick recap. Apple introduced the iPhone 5 and new iPods in late September. It followed with a massive event in October to introduce new thin iMacs, a 13" Retina Macbook Pro, the iPad 4th gen, and the iPad mini. So virtually all of its product lines had new models ramping up production for the holidays. Tim Cook mentioned on the conference call that Apple was supply constrained on the iPhone 5, iPhone 4 (?!), iPad mini, and new iMacs for virtually the entire quarter. So, by their own admission, they missed a lot of potential sales.
No problem, right, they will just get those sales in Q2? Well, no - that's not how consumer electronics works. When customers are buying a holiday gift, and can't find an iPad mini or iPhone 5, they don't and can't always wait. Instead, they may switch to a Kindle Fire, or trade down to an iPhone 4S or 4. Given Apple's Q2 guidance - which is now supposed to be accurate - year-over-year sales growth is only going to be about 7%. This indicates that the company missed a lot of sales in Q1 that are not coming back.
That's a big concern. Tim Cook made his bones as a highly renowned operations manager. This is what he's supposed to be good at. But we're getting some concerning red flags here. The hire and subsequent firing of former retail head John Browett was an embarrassment (retail same store sales were up only 2% in the quarter, another concern). Cook still hasn't hired a replacement. Firing Scott Forstall was another big risk, but we'll see how that goes. And now some poor planning and execution on new product launches.
All this said, Apple's valuation right now is comical. Its EBIT/EV earnings yield is 18.1%, which is far higher than stagnant, declining competitors like Hewlett-Packard (HPQ, Financial) (16%) or Dell (DELL, Financial) (12%). That's just funny. Also, explain to me again why "investors" love Amazon (AMZN), a company that is barely profitable yet continues to trade at nose-bleed valuations?
Consider also the litany of potential upside catalysts. It has been 3 years since the first iPad - do investors really believe Apple has nothing big up its sleeve within the next few years? The launch timing and supply issues are eminently fixable. Apple began buying back stock for the first time in recent memory last quarter and has a ton of capital to accelerate that program, given the current valuation.
And then there's the fact that iPhone picked up significant market share last quarter...
No, this is not a dying company. It is one going through a bit of a self-inflicted rough patch and increased competition. I'll ding the sell early target a bit, but I still see Apple as an excellent Magic Formula choice at current prices. Our target is $700.
