Don't Panic, the Apple Never Falls Far From the Tree

Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Terrible Thursday

On Thursday, the day after Apple (NASDAQ: AAPL) reported earnings of $13.81 a share on revenue of $54.5 billion, Apple's stock fell by over 12%. Last year’s EPS for the same quarter was $13.87 and revenue came in at $46.3 billion, but last year also had a 14 week long quarter compared to a 13 week long quarter this time around. Many said Apple's earnings were flat, but if you factor in that extra week Apple would have theoretically made $14.87 a share on revenue of $58.69 billion. Net income was $13.1 billion, $14.107 billion if you add in the extra week. So when those in the financial media are saying that Apple's earnings were flat or that Apple has lost its magic, you have to consider that extra week and then you realize that it's not as bad as it seems.

An extra week

What does an extra week mean for Apple? Well, it sold about 3.7 million iPhones per week compared to 2.6 million per week last year. That would have bumped Apple's total iPhone sales up to 51.5 million for the quarter. They also sold 1.7 million iPads per week compared to 1.1 million per week last year, which would have bumped up Apple's total iPad sales to 24.6 million for the quarter. A similar story plays out for iPods, Macs, and the other divisions of Apple. Had Apple been given another week it would have hit the "blowout" earnings people wanted.

Cash hoard

Right now Apple's piles of cash total $137 billion, with $94 billion overseas. During the conference call management seemed reluctant to give that cash back to investors, as their CFO stated that Apple "returned about $4.5 billion of cash this quarter and we started the buyback program and expect to return about $45 billion over three years." Peter Oppenheimer (the CFO) seemed like he was trying to defend Apple's current cash allocation stance, but this angered Wall Street and is one reason why the stock was pushed down so hard. Apple currently pays out a dividend of $2.65 a share with a current dividend yield of 2.65%. Right now Apple's total equity is 32.4% of its market cap.

Growth

During the call Apple touted how great of a growth engine China was, talking up the strong iPhone sales and how they opened 4 new stores in Greater China, out of 11 store openings overall for the quarter. The macro trends are also favoring Apple right now in China, with urban wages up 14.3% (8.5% when adjusted for inflation) in 2011. McKinsey Co expects the average disposable income in China to grow from $4,149 in 2010 to $8,185 by 2020 as more Chinese enter the middle class. The iPhone in China can cost you $740 (17.8% of disposable income), but in 7 years that will only be 9% of disposable income, making Apple products look more affordable. In China, owning an Apple product is a sign of prestige, as it shows you make enough money to afford a top tier product. In Q1 2012 Apple's revenue from China grew by 67% (72.15% if you add in another week). In the iPhone's first weekend of sales Apple sold 2 million of the devices. A huge catalyst for Apple going forward would be to secure a deal with China Mobile (NYSE: CHL).

China Mobile has over 700 million subscribers and is by far the largest telecom company in China. China Mobile has made it clear it doesn't want to subsidize the iPhone, but that doesn't mean they can't strike a deal. A deal would greatly benefit both sides, as it would allow China Mobile to bring in more 3G customers which could make China Mobile almost double the revenue from those subs, and it could help boost iPhone sales. China Mobile would be able to compete much better against the competition with the iPhone (which the competition already offers) and it could provide a better selling point for those without 3G data plans to switch over to one. I hope a deal is struck soon, but that remains up in the air. Apple's management does see China as being Apple's biggest source of revenue in the next few years, so maybe they are subtly hinting they want to get a deal done soon.

Valuation

Apple currently trades at a PE (TTM) of 10.7 and at a forward PE of 8.9. When you subtract out the cash Apple has, this company is really trading at a forward PE of 6. A forward PE of 6 implies that Apple isn't going to grow at all over the next few quarters, but that hardly seems the case. Add in a 2.65% dividend yield, and it seems emotions are dragging Apple down more so than concrete evidence (as far as near to mid-term outlooks go).

Problems with MAC

The biggest disappointment came from Apple's Mac sales, which came in at 4.1 million this quarter, down from 5.2 million last year. Management attributed this to supply issues and hinted that next quarter could receive a boost from increased production to meet demand. A supply issue is much better than a demand issue, but Apple should work on filling orders in a reasonable fashion, we can't have 12% stock dips every day.

Increasing competition

One reason for the "lackluster, less than expected" results was because of the increasing amount of competition, primarily in the smartphone space. Google's (NASDAQ: GOOG) Android OS is becoming increasingly popular. In Q3 2011 Android had 57.5% of the global market share. That increased to 75% by Q3 2012, according to IDC. In that same time period, Apple's market share grew from 13.8% to 14.9%. The biggest loser was Nokia's Symbian OS which saw its market share fall to 2.3% from 14.6%.

Google is eating up market share because it offers phones at every price point and is dominating the emerging markets due to much lower price points than the competitors. The success of the Samsung Galaxy S3 is also attributed to the iPhone's slower growth, as it is considered to be similar in quality to the iPhone 5 and is the same price, more or less. To show just how fast Android has been growing, one should look at its historical market share. In 2008 Android had 0.5% of the global market share. In 2009 that grew to 4%, in 2010 it grew to 23.3%, got up to 49.2% in 2011, and now it at 75% as of Q3 2012. Impressive, and something that Apple needs to keep in check. That is why it is so important for Apple to be able to differentiate its brand from everything else and to innovate gadgets that the competitors don't have. Android is also a problem for Apple in China, because it controls 72% of the Chinese smartphone market due to its low pricing points.

Final thoughts 

Apple is facing increasing amounts of competition, its margins aren't as high as they used to be (38.6% versus 44%), and it didn't post the earnings people wanted. But, this is a company slated to grow its EPS by 18% over the next few years, yet it trades at 6 times forward earnings when you subtract the cash. Apple's stock is dirt cheap right now and has plenty of catalysts ahead of it. The release of a cheaper iPhone, the iTV, a new iPhone, and new line up of iPad and iPad Mini's (which have a higher margin than the iPad), and the expansion into new countries all will benefit Apple's shareholders. Emotions have pushed Apple's stock down big, but fundamentals will pick this stock up in the long run. I'm bullish on Apple. Even if Apple doesn't hit double digit growth, high single digit growth should sport a higher PE than 6.  


callumturcan owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, China Mobile, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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