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January 23, 2008

Apple: Not Good Enough For This Stock

I am not going to recap all the numbers from Apple as you can read that elsewhere. The December quarter was very good but not without issues. Mac and iPod sales came in a little below aggressive estimates. This was easily made up by better than expected ASPs. A bigger issue will be that US iPod units were flat and were a little weaker in the holiday season than the first part of the quarter. Be ready for the iPod is dead headlines. Management said it was happy to trade units for ASP and this was part of the strategy behind the Touch. I see nothing else to quibble about in the December quarter.

Guidance for the March quarter is the real issue that took the shares down 10% after hours. 94 cents on revenues of $6.8 billion is below the $1.09 and $6.98 billion consensus. In its last quarterly report Apple actually guided above consensus so while they are very conservative, there is some precedent to interpret this guidance unusually negative.

The guidance assumes much worse sequential performance than has occurred the last two years....

....Revenues are projected to drop 29% vs. drops of 26% and 24% the last two years. EPS are expected to decline 47% vs. 24% and 28% the prior two years. On the call an analyst pointed out that last year management guided to a 52% sequential drop in EPS and came in at 24%, thus he asked what has changed to prevent this from happening again. I think he has an excellent point with one caveat. Last year's March quarter was the first one where gross margins exploded due to collapsing component costs. That said, gross margins in the December quarter were just 40 basis points below the March 2007 quarter and on the call management said that component costs looked pretty similar for March 2008 as December 2008. They pointed to fewer Leopard sales and less cost of goods sold leverage due to lower sales as the reason for assuming a 250 basis point sequential drop in gross margin. The gross margin guidance seems conservative on this basis and more so when remembering that Macs are gaining in the sales mix and have higher margins than iPods.

The next thing I did was try to plug in unit volumes and ASPs for Macs, iPods, and iPhones to get to the $6.8 billion revenue guidance. I couldn’t do it. I consistently come up slightly north of $7 billion. I am using similar sequential moves in units and ASPs as prior quarters. Given momentum in Macs, I think this is conservative.

The stock now trades at 20 times 2008 estimates which I still think are going higher given that Apple beat 1Q consensus by 25 cents and 2Q guidance is only 15 cents light (and ridiculously conservative). EPS rose 55% in the December quarter. The current consensus for 2008 implies 25% growth. I think the shares are offering an attractive entry point. However, there is just enough here for the bears to make hay so I do not expect a quick rebound from the $138 after hours level.

Posted by Steve Birenberg at January 23, 2008 10:41 AM in AAPL