Last night Apple reported Q4 fiscal 2012 earnings. In what seems like a case of deja-vu, the stock slipped by a few percentage points in after market trading. What’s knocking Apple down this time? Well, they shipped a lower number of iPads than Wall Street expected in the quarter, and guidance for the holiday quarter is lower than expected. And the sooner we learn to ignore the short-term nature of Wall Street thinking, the better.
Just to recap, last quarter the stock dropped 5% in after market trading because of perceived weak iPhone sales and weak guidance. Then, within a few weeks, the stock had climbed from about $575 up to $700. Subsequently, it has now dropped back down to about $609. It’s a volatile stock and that’s just something you have to accept if you participate in the stock market.
Let’s take a quick look at the key numbers: Apple delivered $36 billion in revenue and $8.66 in earnings per share (EPS). Gross margin was 40%. This is significantly better than guidance, but then again Apple is notorious for giving conservative guidance. Nothing has changed.
Apple’s largest product is the iPhone. In Q4 they sold 26.9 million units, which is up slightly from 26 million units last quarter. Customers knew the iPhone 5 was coming, and people obviously held off on iPhone purchases until it launched, considering the 5 million units sold in the first week after launch.
iPad sales were only 14 million units. This is down from 17 million last quarter, and Wall Street is a bit worried about this. Analysts expected more iPad sales, despite the fact that Apple says sales exceeded expectations. I wonder if people held off buying because of such huge anticipation for the iPad Mini, which Apple just announced this week. Still, iPad sales are up nicely on a year-over-year basis and are bound to be up dramatically in the December quarter. So I’m not worried.
Mac sales and iPod sales were solid, as usual. Macs continue to outgrow PCs, which means Apple is gaining on Microsoft in terms of OS market share. This is a trend that has been ongoing for many years, and shows now signs of slowing down. That’s great news for Apple shareholders.
Is profitability dropping?
During the Q&A session of the conference call, one analyst pointed out that if Apple’s guidance plays out, it will mean an earnings decline year-over year. Why would Apple tell Wall Street to expect the December quarter to be less profitable than last year’s comparable quarter?
CFO Peter Oppenheimer had a well-scripted and quite reasonable answer to this question. First of all, Apple’s December quarter will only be 13 weeks this year. Last year it was 14 weeks, so we should expect a 7% headwind from that alone.
But far more important is the huge refresh of products that Apple just threw at us. The iPhone 5 will be shipping for the entire quarter. The new 4th generation iPad and iPad Mini will ship for the bulk of the quarter. We’ve also got new 13” Macbook Pros and iMacs hitting us. I think Apple is correct in saying that they’ve never had a quarter with so many new products hitting all at once.
Here’s the thing about new products - they cost more to make than the prior generation of product. They have better screens, faster processors, and other component enhancements. This cost hits Apple, yet they don’t raise prices. Instead, they work their way down the cost curve over the life of the product. So the gross margin takes a hit. It’s a step change. And because Apple is launching so many products at the same time, it’s a lot of step changes in the wrong direction.
Apple is also introducing the iPad Mini, with a significantly lower price point versus other iPads. It has a lower gross margin. So profitability goes down.
As an investor, none of this bothers me so long as Apple can do two things. First, it has to prove that it can get costs down on new products just as it always has. This shouldn’t present much of a challenge. Second, they need to show me that the iPad Mini expands the overall market for iPads. If the Mini doesn’t accelerate iPad unit growth, then Wall Street can correctly say that Apple either canibalized its own profits, or was forced to take this step due to pricing pressure from competing 7” tablets.
If iPad sales improve with the new form factor, I look at is as Apple gaining more share and capitalizing on a portion of the market that was shopping elsewhere, or not buying tablets before. But if iPad sales don’t grow then Apple has simply lost profit, which is bad. For the record, I expect the former situation to unfold.
The bottom line
I’m pleased with Apple’s quarterly performance and I understand the reason for their guidance falling below Wall Street expectations. I take a longer term perspective on the business than most analysts and investors. I love the products they’ve just unveiled and it’s obvious to me that I’m more likely to increase my spending on Apple products than slow it down. If others feel the same way I do, that’s good for the stock.
In the mean time, if you are an Apple shareholder, learn to stomach the volatility. It’s not going away.
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