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October 31, 2013

Another Solid Quarter and Guidance As Apple Ripens Again

Apple reported better than expected earnings for the second consecutive quarter. Guidance for the December quarter was confusing but ultimately better than Wall Street expectations. This sets the stage for a continued recovery in Apple shares into year end. Datapoints on product sell through for the new iPhones and iPads and a possible deal with China Mobile for iPhone distribution are catalysts most likely to move the shares.

The biggest risk relates to the outlook for the March quarter. The timing of the rollout of iPhones this year on a geographic basis may pull some demand into the December quarter that was in the March quarter last year. In particular, China shipped in the March quarter in last year’s product cycle.

Thinking longer term the two big issues remain whether Apple needs a truly low cost iPhone and where gross margins end up. The new iPhones and iPads appear to support gross margins but many analysts feel that Apple has saturated the high end of the smartphone market and can no longer grow consistently without a low-priced phone. Furthermore, there is a worry that if Android gains too much market share, Apple’s big advantage with app developers will be lost and the network effect that drives Apple’s business model will suffer.

For now, I think it makes sense to continue to show patience. After a year of declining earnings, Apple appears poised to show growth in the December quarter. Comparisons are much easier in the March and June quarters as those are the periods during which gross margins were declining sharply from peak levels in 2012.

A return to growth should allow some multiple expansion for Apple shares. At 12 times the 2014 consensus estimate of $47, the shares would trade at $564 giving no credit to $143 cash per share on the balance sheet as of September 30th. One more good quarter and decent guidance for the March quarter and the shares could reach well north of $600 within three months.

Clearly this is a bullish case and risk exists that products do not sell well enough to meet earnings estimates. However, two straight above average quarters, well-reviewed new products, early indications that sales are good, and a better product mix that helps margins, suggest near-term optimism is warranted. For Northlake clients, that is good enough. If the stock works to $600 and above, we can worry about the long-term issues.

AAPL 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. AAPL is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Posted by Steve Birenberg at October 31, 2013 01:57 PM in AAPL