Apple Q2 – Cash Compensation

The payoff for investors is a fair one.

• Apple played its trump card to keep investors happy by announcing a large increase in cash returns following mediocre results.

                              Q2A                      Consensus

Macs                     3.9m                           4.1m

iPhone                 37.4m                         35.4m

iPad                      19.5m                         18.5m

iPod                      5.6m                          6.0m

Revenues            $43.6bn                     $42.3bn

Gross Margin      37.5%                         38.5%

EPS                       $10.09                        $9.98

Source: Company Data, Bloomberg, Radio Free Mobile

• Guidance was weaker than expected with revenues of $33.5bn-$35.5bn expected compared to consensus at $38.43bn.
• Q3 gross margins are expected to be 36%-37% compared to forecasts of 38.8%.
• Remember that Apple recently stated that it would no longer low ball the guidance and so if we take it at its word, this is disappointing guidance.
• However, to make up for the softness, Apple is doubling its cash return program to $100bn from $50bn via an increase in the dividend and the buyback running until 2015.
• The biggest problem is that iPhone ASPs are beginning to fall.
• This implies that demand for older devices and lower storage versions are rising which strongly points to saturation of the $600+ segment.
• Furthermore, guidance implies that iPhone shipments in Q3 will be little changed YoY against a market that is growing at 30% in volume terms.
• Hence, if Apple wants to see growth in revenues and earnings again it must either address the growth segment of the smartphone market or enter new product categories like the much rumoured iWatch or iTV.
• For the first time Apple talked about its launch schedule and guided that autumn 2013 would see new products and services.
• Commentary was also strongly suggestive of new product categories rather than just upgrades and refreshes of existing products.
• Here, the lead contender is a mid-range iPhone.
• For the first time since this question first arose (3-4 years ago), the Asian supply chain is corroborating the story.
• This means to me that the devices have been created but whether they are going into full production is uncertain.
• This is a dangerous step.
• Apple could easily re-ignite unit growth but the cannibalistic effect of a mid-range device and falling ASPs could easily wipe out revenue growth.
• Furthermore, Apple does not do cheap very well meaning that there are greater risks attached to execution of this product than the rest of its portfolio, should it be launched.
• Apple’s valuation remains unchallenging, and the return of cash to shareholders should provide some support to the shares.
• On a long-term basis, I like the shares as the free cash flow generation is first class and nothing has really emerged yet to properly challenge the iOS ecosystem.
• If Apple can create some decent services that iOS users come to love then it can start to edge out Google and the other third party service providers on iOS and take more of that value for itself.
• However, with recent missteps like Apple Maps, iCloud and Mobile Me, this remains the company’s greatest challenge.