From Bear to Bull, Apple is Back

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

In just over two months, Apple (NASDAQ: AAPL) shares fell 25%, from a high of $700 to a low of $507 and began a rise again, closing yesterday at $589.53 per share. News and sentiment have shifted dramatically. The negative headlines surrounding Apple's hiccup with a subpar Maps App has been lost in the wind. Sentiment officially changed from bearish to bullish when one analyst delcared the degree of the sell-off "insane." Since then, headlines have turned bullish yet again. With FQ1 in sight, Wall Street is now forced to reckon with Apple's upcoming holiday quarter. What can we expect from the tech giant in FQ1? Can Apple deliver?

The Winds Are Changing
Apple's Q1 results are still a ways off, but earnings estimates and analyst upgrades are beginning their typical cycle already. Barclays reported yesterday that, according to its "checks," Apple could sell as many as 50 million iPhones in Q1, 7 million more than current estimates. Also, yesterday the shipping estimates for the iPhone 5 dropped to 1 week for the first time as Apple begins to catch up with demand. To top it off, according to research from Kantar Worldpanel, Apple's iPhone sales helped Apple finally knock Google's (NASDAQ: GOOG) Android to second place, with 48.1% market share of US smartphone sales compared to Android's 46.7%.

New Products
Tim Cook spent quite some time during the FQ4 earnings call discussing the sheer volume of new products it expects to sell in the holiday quarter. Consumers literally have a plethora of new Apple products to choose from: the iPhone 5, the 4th generation iPad, the iPad Mini, an entirely new iPod line-up, a 13" inch Macbook pro with a retina display (pausing for a breath), and the Mac Mini. Oh yeah, don't forget about the new iMac rolling out on Friday.

To put this in perspective, Apple is projecting 80% of its revenue in FQ1 to come from new products. Apple's guidance for gross margins in FQ1 were lower than expected, but for those who were listening to the earnings call closely, Peter Oppenheimer put the lower than expected guidance for margins into perspective, repeated mentioning that there is no negative change to the cost structure. The lower guidance for margins is simply a result of having so many new products available at the same time.

Q1 Expectations
Another golden jewel from the FQ4 earnings call was Oppenheimer's comments on the manner in which Apple's cost curve improves. Some of the costs include the amortization of new manufacturing equipment that come hand-in-hand with new products. This amortization, however, does not increase incrementally with each unit sold--it is fixed. Therefore, with 80% of sales in the quarter expected to come from new products, any beat on unit sales on any of the products could increase profit margins. If Apple beats its own internal forecasts for iPhone unit sales by a large margin, gross margins will likely be drastically better than expected, given that iPhone sales currently represent 51% of total revenue.

If Apple beats estimates to the same degree it did last holiday season, investors might be in for a blockbuster show. Last year, Apple crushed Wall Street estimates in FQ1. With $46.33 in revenue and $13.87 in earnings, Apple topped estimates by 18.5% and 36.5%, respectively. Representing such a large chunk of total revenue and profits, iPhones are always the big item to watch. Last year, Apple topped Wall Street's estimates of iPhone unit sales of 30 million by a whopping 7 million units. Wall Street was euphoric. Apple's stock rose 50% over the next two months.

The iPhone 5 Launch in China
With iPhone 5 shipping estimates falling to one week just before the alleged launch of the iPhone 5 in China, Apple could really capitalize on adding China to the holiday quarter. Tim Cook assured investors during the earnings call that a December launch in China was still planned. Last year the iPhone 4S didn't make it to China until January 13th (FQ2). 

A Compelling Valuation
Much of the return to the bullish sentiment surrounding Apple's stock is simply a result of a fundamentally cheap valuation. Based on a discounted cash flow analysis I wrote about on Nov. 9, I declared Apple shares 35% undervalued. Of course the share price has increased 8.5% since then, but I still consider the shares fundamentally undervalued for the long-term investor.

Measured by my favorite, straight-forward valuation metric, free cash flow (FCF) yield, Apple is available at a great price. FCF yield shows you what percentage of a company's share price is represented by the cold, hard cash it's churning out. The higher this percentage, the better. But Apple is fundamentally cheap from whatever angle you choose to look at it. Let's compare it to some other wide-moat, mega-cap stocks based on three valuation metrics:

Company P/E P/Foward Earnings FCF Yield
Apple 13.4 9.6 7.7%
Google 20.6 14.5 6.8%
Wal-Mart (NYSE: WMT) 14.7 12.5 6.7%
McDonalds (NYSE: MCD) 16.3 14.9 5.6%
Procter & Gamble (NYSE: PG) 22.6 15.4 4.5%

The bottom line
There is no doubt that FQ1 will be a big quarter for Apple. The question is: To what degree? With 80% of sales expected to come from new products and an uncertain time-frame for the iPhone 5 launch in China, it's going to be tougher for analysts to estimate unit sales. Will Apple obliterate estimates, just like last year? Or will it barely match estimates? Either way, at today's valuation Apple shares are available at a great price.


DanielSparks owns shares of Apple. The Motley Fool owns shares of Apple, Google, and McDonald's. Motley Fool newsletter services recommend Apple, Google, McDonald's, and The Procter & Gamble Company. 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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