Today I contributed the following commentary on Apple Computer to StreetInsight.com, the professional service of theStreet.com. Since Northlake clients are long Apple in their portfolios, I thought the note might be of interest. I have also included the text of two other comments on Apple that were contributed by other money managers who contribute to the various websites owned by theStreet.com:
Based on reports from various Apple Stores around the country it appears the iPod nano is major hit. Numerous stores had lines at the cash register and traffic was extraordinary. At the Apple Store where I bought my nano, the sales people reported that much of the initial traffic was from people who already own iPods. I think that the nano will drive a major “upgrade” cycle for current iPod owners in addition to bringing even more buyers (according to AAPL only 6% of the people in the United States own an iPod). The nano, with 500 or 1000 song capacity is a nice compliment to a currently owned 20 or 40GB model. It is also a nice upgrade over a shuffle. I think the nano will be the hot product this Christmas and current estimates for total iPod unit shipments over the next two quarters are low….

….Last quarter, AAPL reported a gross margin just short of 30% and SG&A as a % of sales of 13.4%. For sake of argument, let’s say AAPL ships an incremental 1 million iPods due to the popularity of the nano. Using the average retail price of the 2GB and 4GB versions of $225, AAPL would realize an incremental $225 million of revenue. Applying a 30% gross margin, a 15% SG&A ratio, and a 33% tax rate, an incremental 1 million iPods would produce $22 million in net income and 3 cents per share in earnings.
I believe this math could be conservative. First, I believe iPods have a higher than corporate average gross margin. Titus Menzies (another contributor to Street Insight) calculated that AAPL might earn a 43% gross margin on the 2 GB nano. Second, I believe an incremental 1 million shipments may prove low. Through the end of last quarter, AAPL had shipped more than 21 million iPods (another 6 million or so likely in the quarter ending 9/24/05). I think at least 10% of those iPod owners will add a nano to their collection. Even if some of those folks would have bought another iPod, there will clearly be first-time buyers attracted to the nano sooner than expected due to the incredibly positive product reviews and word-of-mouth.
So let’s say Titus is correct and the gross margin is 43% on an incremental 2 million nanos. Keeping SGA% and the tax rate constant, that creates an additional 10 cents in EPS.
I believe AAPL books revenue based on shipments, not final sales. It is hard to guess how many nanos will be shipped by the end of the fourth fiscal quarter on 9/24. However, I think it s fair to guess that estimates for the fiscal year that begins on 9/25 will rise by about a dime. Consensus is presently $1.63 with the high estimate at $1.75. So assuming current estimates are accurate, at $51, AAPL trades at 29 times forward earnings. There is almost $9 per share in cash on the balance sheet generating 15-20 cents in EPS, so alternatively AAPL is trading at an adjusted price of $42, or 26 times cash adjusted EPS.
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