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July 20, 2011

Another Apple Blowout as Emerging Markets Lead

Apple reported another blowout quarter. While that is never surprising, there was some reason to be concerned going into the quarter. Supply constraints have left uncertainty about the true level of iPad demand. Verizon iPhone sales have been good but not great. Pending product transitions including the new Lion operating system and iPhone5 could have served to slow demand. Alas, none of the worries were warranted. Massive upside in iPhone and iPad unit shipments and better than expected margins drove EPS to $7.79 vs. the consensus expectation of $5.85. My own spreadsheet was dictating $6.20.

The only issue that came up on the conference call or in the press release was guidance for the September quarter. Apple guided to EPS of $5.50 on revenues of $25 billion against consensus of $6.03 and $27.7 billion. Given that Apple's guidance has become a running joke, this is not a major concern. However, I have noticed that Apple shares tend to respond in the short-term to the guidance. When guidance is in line to ahead of consensus, the stock responds positively and vice versa. I think that the subdued reaction today to Apple's earnings last night is probably this relationship in action.

Working backwards from management comments on the conference call about iPad, iPhone, and iPod trends, I think guidance assumes iPhone 5 does not ship until the December quarter. Guidance also reflects the newly announced revenue deferrals across the product lines related to Lion and iCloud. Analysts are not lowering their estimates for the September quarter and are dramatically raising estimates for 2012. I don’t really care whether iPhone5 ships in September or October as the demand is clearly going to be sky high.

One other takeaway from the report and conference call is that Apple's business in emerging markets, most definitely including China, is booming. This geographic segment grew 247% last quarter and represented 22% of sales. In China alone, management indicated revenues were up six times from a year ago. While a lot of focus remains on iPhone vs. Android in the U.S. and the level of demand for iPhones at AT&T and Verizon, the real story is how well iPhones are selling in emerging markets. The bull case for Apple has always been relatively low market shares in very large and growing end markets defined by product. We can now expand the addressable end markets dramatically to include geography, specifically emerging markets.

I remain bullish on Apple. I think there is a good chance that fiscal 2012 EPS will exceed $35. Apple has $81 in cash today on its balance sheet and should have around $110 by this time next year. Put a 15 P-E multiple on $35 in earnings and add $110 in cash and you arrive at a target of $635, still more than 60% above current levels.

Disclosure: Apple is a net long position in the Entermedia Funds. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in the Funds' investment management company, and has personal monies invested in the Funds. Apple is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor.

Posted by Steve Birenberg at July 20, 2011 12:49 PM in AAPL