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January 25, 2010

Another Good Quarter Validates Apple Bull Case Despite Confusion

Apple reported another good quarter (revenue +32%, EPS +44%) although investor reaction was unusually muted as the company unexpectedly switched its revenue recognition policy for iPhones. Apple has been reporting “adjusted” results based on the new accounting for several quarters and most investors new a switch was in the pipeline. However the company gave no indication the change would come this quarter. As a result, there was no real way to compare Apple’s results or the March quarter guidance to estimates. This confusion I think led to a muted reaction.

After quickly updated my spreadsheet with the new historical reported results, it looks like another very good quarter although not a massive upside blowout compared to restated estimates. Guidance looks pretty good in that it appears to roughly match analyst estimates. Apple usually guides below the Street.

The quarter saw better than expected Mac units, which is always helpful as Macs sell at an average price of $1,324, or 8 times an iPod and 2 times an iPhone. iPod units were down 8% but this a little better expected and iPod revenue got a boost from 55% growth in the touch which boosted average selling prices to their highest level since the March 2008 quarter. iPod revenue was actually up 1% despite the 8% unit volume decline.

iPhone units were a bit below expectations at 8.7 million, up 100% from a year ago. On the call, management provided reassuring comments when it stated they could have sold “a lot more” but are managing inventory very tightly.

As to the accounting change, there is nothing negative to read into it. Apple has been deferring significant revue form the sale of iPhones to wireless companies like AT&T due to a strict interpretation of accounting standards. The change puts Apple in line with other cell phone manufacturers like Research in Motion (RIMM) and Nokia (NOK), whereby almost 100% of revenue is recognized in the quarter in which the phone is shipped. In other words, compared to its peers, Apple has been massively understating its iPhone revenue and earnings. This change actually increases transparency, which is always a good thing.

Based on restated numbers, Apple earned $9.13 in its fiscal year ending September 2009. 1Q10 EPS gained 44% and the company guided – likely conservatively – to 18% growth for 2Q10. Let’s say Apple’s EPS in 2010 rise 30% to $11.87. Within that EPS is less than 10 cents per share of earnings on $43 per share of current cash reserves. By year end, cash reserves should be north of $50.

At $205 in after hours trading, Apple trades at $155 adjusted for cash on an EPS estimate of $11.80. The P-E of 13 seems awfully cheap given the near-term operating momentum, still massive market share opportunities in Macs and iPhones, the tailwind of smartphone adoption, and potential new product categories such as the tablet to be introduced on Wednesday. Put an 18 multiple on Apple and add back the cash and you have a stock near $265, up 30%.

I actually think that $11.80 will prove low for 2010 and 2011 could be near $15. 18 times $15 plus $50 in cash equals $320. In a good market, that seems a reasonable target for this time next year.

Apple stock will always highly susceptible to profit taking and market pullbacks so timing is important. But current holders can feel very comfortable in the value of their shares and not worry greatly if the stock pulls back. The shares are still a buy at current prices but any pullback related to market conditions would be an ideal entry point.

Disclosure: AAPL is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.

Posted by Steve Birenberg at January 25, 2010 05:31 PM in AAPL