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April 24, 2014

Finally A Good Quarter for Apple

Apple reported its best quarter with revenues, earnings, profit margins, and iPhone sales all easily exceeding Wall Street estimates. In addition, the company materially increased its share buyback program, raised the dividend by 8%, and announced a 7 for 1 stock split effective in June. Finally, guidance was within an acceptable range with revenues a little below the Street but EPS in line. Not surprisingly, the shares are responding well, up 8%.

Last quarter when I wrote up Apple’s results, I expressed great frustration with progress the company was making in reinvigorating growth. I also noted that the frustration was coming from a long time Apple bull. I have thought for several quarters that the set up in Apple shares was good given what seems like relentless negative sentiment toward the company and the stock. Expectations about Apple’s growth had come way down and it appeared that many institution investors had sold their stock. What was lacking was a positive catalyst. I had been looking toward a resumption of growth in net income, a much bigger share buyback, the long promised new product category, or just better performance of the core iPhone/iPad/Mac business.

The just reported quarter gave us everything but the new product category. Net income grew 7%, the first positive result in six quarters. The share buyback was upped by $30 billion. iPhone surprised to the upside with units of 43.7 million vs. consensus of 38.5 million. Gross margins came in well above guidance and estimates at 39.3% vs. 37.5% expectations. Results in China improved and iPhone showed particular strength in emerging markets. CEO Tim Cook still is promising new product categories this year and a larger screen iPhone 6 has the potential to act like a new category giving consumer demand for large screen phones all around the world.

There were some blemishes in the quarter, especially iPad sales falling well short of estimates. Also, iPhone average selling prices fell sequentially by more than expected. iTunes and Software and Services also continued to see decelerating growth. Finally, as noted above, revenue guidance for the upcoming quarter was below consensus estimates.

The bottom line for the stock is that I think the coast is clear for the rest of this year with a potentially good setup to extend today’s gains. New products and the larger iPhone screen iPhone provide good outlook for the second half of the calendar year. The strong quarter, share buyback, dividend increase, and stock split provide support to get through the long feared June quarter.

Investors should have confidence EPS of $42.50 for this year and $46.25 for next year. If iPhone 6 is all in FY15 (released in October 2014) and share buybacks continue as promised, the $46.25 looks low. Given the financial strength and more confidence in growth for a couple of years, the P-E of 12x after today’s big gain still seems cheap. Adjust for $150 in net cash on the balance sheet, the multiple is more like 9x.

Apple is not out of the woods and a return to the glory years will not happy unless the company finds a new product category at least as big as iPad. However, a run at the all-time high of $702.10 is not out of the realm of possibility if Apple can string together three more good quarters this year. A new high would bring a gain of 25%, enough to justify owning Apple given the better fundamental support coming off the company’s first real good quarter in 2 years.

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. Northlake’s regulatory filings can be found at www.sec.gov. AAPL is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Posted by Steve Birenberg at April 24, 2014 01:25 PM in AAPL