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January 23, 2013

Apple Earnings OK, Guidance Poor, New Controversy

Apple reported largely inline December quarter results. Revenues of $54.5 billion were barely shy of consensus and EPS of $13.81 were barely above consensus. Gross margins exceeded guidance and were close to the most optimistic street estimates. Product sales were about as expected except for Macs, which missed by lot.

Guidance was below the street as usual. There was hope that guidance would be closer to the analyst estimates which would have eased concerns about demand for iPhones and iPads, gross margins, and negative datapoints from the supply chain.

The actual earnings and guidance were greeted by a quick 6% drop in the shares. I'd call that fair as essentially the quarter and guidance left the recent controversies intact and provided no relief for the bulls. The way the street works that gets the stock back to the low end of the recent range. Not great but not a disaster if you believe as I do that underlying product demand is growing.

On the call, the company explained its new approach to guidance. Here is the exact quote:

“In recent years our guidance reflected a conservative point estimate for results every quarter that we have reasonable confidence in achieving. Going forward, we plan to provide a range of guidance that reflect our belief of what we are likely to achieve. While we cannot forecast with complete accuracy, we believe we are likely to report within the range of guidance we provided.”"

This comment dropped the stock another 6% to where it trades now as the conference call concludes, $459, down 11% from today's close. The issue here is that management seems to be saying that previously guidance was "conservative" and now it is "what we are likely to achieve." Management denied to expand on this quote when given a couple of opportunities in Q&A to admit that the shift still leaves guidance as "conservative." I do think the second attempt by an analyst left open the possibility that guidance is conservative.

The reason this matters is that low-balling guidance meant that this quarter's guidance disappointment probably wasn't that bad as the actual report would be close to analyst estimates. If this quarter's guidance is real, then analyst estimates are going to have come down sharply. Current FY13 consensus is $48. That would imply $24 in second half earnings if guidance is taken at face value, a 33% gain year over year.

However, with a just reported flat quarter, guidance for -20% quarter, and ongoing worries about demand due to the supply chain datapoints and production cuts, analysts and investors are never going to believe a quick rebound to 33% growth.

If this year ends up with EPS in the low $40 range, down 5%, the shares look pretty cheap as long as growth resumes. With $144 in cash, call it $120 after-taxes, the stock is trading at $340 against $40 in operating EPS. Very cheap if growth resumes. But we aren't going to know whether growth resumes for a few months.

I believe growth will resume. I also believe that guidance is going to prove conservative again. Underlying product demand looks a lot better than the stock price to me. Until I am proven right, however, the stock is in the penalty box with minimal upside. I think it is worth holding on but expect the bumpy ride to continue and when growth does resume think $500s not $700s.

Apple is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov. Apple is a net long position in the Entermedia Funds. Steve is portfolio manager of Entermedia, owns a controlling stake in the Funds' investment management company, and has personal monies invested in the Funds.

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Posted by Steve Birenberg at January 23, 2013 05:03 PM in AAPL