Can Apple Really Get Worse Before It Gets Better?

When analyst Gene Munster of Piper Jaffray, a renowned bull of tech giant Apple (NASDAQ: AAPL  ) , decided it was time to lower expectations for the coming quarter, I realized I had no choice but to listen. After all, given the punishment that the stock has already suffered, falling almost 35% over the past six months, it would seem that expectations are already low. Besides, it's not as if Apple has ever enjoyed a robust price-to-earnings ratio like Amazon.com, whose P/E often sits well in excess of 100 and presumes ever-lasting growth.

Apple's music had already stopped last September, when shares began their descent. Nevertheless, Munster, who proudly wears the Apple fanboy moniker and has a price target on the stock of $767, issued a note on Tuesday to clients warning that the Street's expectations, although lower, are still too high. Munster advised that "the company will have to get through a dry patch before things start looking up again." I shook my head at the thought and wondered: Does the Street really have a good grasp on this company?

What is Apple today?
With the stock price still at depressed levels, investors are trying to understand what the company really is. Is Apple a value play or a growth stock? And if it's true that things can still get worse, especially after all of the punishment, it's time to reassess Apple's position as a tech leader. There's also the issue with the company's $137 billion cash hoard. Investors are demanding that the company buy back shares or increase the dividend.

Management claims to be listening, but so far there's been no response. With regard to the stock, management hasn't shown that it cares about shareholders' petitions. Granted, the team is focused on the long term. But the company's direction is still unclear. And I'm becoming increasingly convinced that management may not know. The team recently said that Apple is a "software company." But when looking at Apple's actual business, it's hardware that rules in terms of gross sales and margins.

Besides, other than periodic updates of Apple's iOS, there has been no real announcement suggesting how software is ever going to drive long-term growth. Meanwhile, aside from constant rumors of a watch and a TV, there are no clear signs of what's next. And the only sign that's become apparent lately is that Apple is no longer the champion of flawless execution that it once was. Meanwhile, Google has been hitting new 52-week highs and BlackBerry's new phone just landed on the market. Is this what Munster is warning against? 

Where has all the growth gone?
Since hitting a 52-week low of $419, the stock has been as high as $469, increasing 12%. It seems Apple is turning the corner, or the stock has bottomed. Sentiment is beginning to change. So why now did Munster think it was time to issue his warning? He's modeling for lower revenue growth at $41.3 billion, which is the low end of management's guidance, and below Street estimates of $42.8 billion. Is this the "worse" he's referring to?

Consider this: In the second quarter of 2012, Apple posted year-over-year revenue growth of almost 60%. Let that sink in for a second. Revenue jumped from $24.7 billion in Q2 2011 to $39.2 billion in Q2 2012. However, this time the Street is calling for just 9% growth, which will be down from the 18% Apple posted in the first quarter. And if Munster is correct with his revenue projections of $41.3 billion, Apple would have grown only 5% in Q2. That suggests a growth deceleration of 55% in one year.

Munster also sees as much as 2.5% lower gross margin -- more bearish than what the Street is forecasting. Will these numbers spook investors into another sell-off? Plus, Munster doesn't expect Apple's third-quarter report, which will come out in June, to be any better. This scenario certainly qualifies in one in which Apple is getting worse. 

Where's the "better" part?
Growth of 5% is not Apple-like, nor will the company be satisfied with it. But Apple can reinvigorate growth by launching a cheaper iPhone, which is widely anticipated. The lower-end market is one the company can no longer ignore, especially if Apple is really committed to entering the Chinese market. But that's going to come at a cost. Apple will have to sacrifice some margin to make this work.

The good news, though, is that Samsung's new Galaxy S4 is not overwhelming, and neither is BlackBerry's Z10. That should help preserve market share until Apple is able to release new products later this summer. In the meantime, by reducing expectations for this coming quarter, Munster has done Apple a favor. Whether this move was deliberate depends on your point of view. But it's nonetheless encouraging that the Street is (at least) willing to consider that Apple has been beaten enough and that the company, while still very valuable, may be readying for something bigger -- or, in this case, better.

There's no doubt that Apple is at the center of technology's largest revolution ever and that longtime shareholders have been handsomely rewarded, with more than 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple and what opportunities are left for the company (and your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


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  • Report this Comment On March 30, 2013, at 3:26 PM, DanManners wrote:

    Apple is having lower highs and maybe lower lows. We will see now. If it can't hold 420 or abouts we have some serious problems. Apple has not had much news going on 8 months. With the stock down 40 % you would think the company would say a little more than "We feel your pain". What do they say at next years annual meeting, "We feel your death?"

    Many say Tim Cook cannot lead Apple. Rocco Pendola of the Street.com said it best. But he is right. Cook was a great solider under the leadership of the great Steve Jobs. How can a soldier be promoted to run the biggest US company ever? Why was another great CEO brought in to run the company.

    Look at other great Apple employees. Scott Forstall who was the creator of the maps fiasco and Ron Johnson who ran Apple's retail business who has single handedly destroyed JC Penney. THose employees were great with Jobs leadership. With Cooks leading the company they were just a bunch of hacks.

    Cook needs to go immediately. He has seen the stock down as much as 285 points in a few months. How much lower does it go under his leadership? Bethany McLean of Vanity Fair said we go to $ 200 and Ed Zabitsky of ACI Research has a $ 274 price target. Valuewalk has a target price of $ 50.

    So lets say we go down to $ 380 as CGI research said. That would be a $ 325 point drop from the hight. What does Cooks say? Does the board let him stay on? At $ 274 which is $ 170 less then where we are and Zabitsky has this as a PT in 3-6 months, does Cook get dumped.

    No! Not when Board members like Al Gore are richly rewarded. I am not sure what hard work they do? Why would they command so much money that dilutes the shares and causes the stock to go down more?

    With the Fool covering Apple we are very lucky to get many points of view. But with the next two earnings reports to be bad and having 4 of the last 5 earnings reports as misses, it will get much worse before it gets better. We droped 100 points after the last released earnings in January. So we should be at $ 320 or lower based on that.

    I expect only a small upgraded iPhone 5s with the same size screen and some mild upgrades on the ipads. No bigger screen iphone, no cheaper phone, no China Mobile agreement, no big dividend increase and no iTV. As a matter of fact China has been bashing Apple over their warranty. Apple might end up with decreasing China sales and that might cause them to start shifting manufacturing out of China. That might even cause a bigger Chinese backlash and the stock will tank endlessly.

    I see only bad news coming out about Apple every day. Endless downgrades. Endless news about subsidies being cut. Endless news about new phones that are coming out everywhere to compete with the iphone. Endless new products from Google. Endless price challenges to Apples margins.

    Apple will be far smaller in a few years. They will still be formidable but much smaller than they were at the top. They will be just another player in the market though a big player. But just not that big and declining steadily.

    The one factor that may keep a bottom on the floor of the stock price is the cash. If they don't give it back to shareholders and they won't, the fact that they would have $ 250 billion down the road will keep the stock from going below $ 200. That is why they don't squander it. Of course that cash will not grow as fast and could start to diminish when the dividend starts exceeding cash made.

    With a secretive comapny like Apple, who can really be sure what is going on. That is a reason not to own the stock.. Why can't a company be giving constant news about how they are doing? The shareholders position becomes that much more of a gamble. They hold the stock loyally and are repaid with no buybacks or help from the company. I can get alot of people to say they feel my pain without losing 40% of my money.

    Well Cook has enough money to last him a life time but when he gets canned I won't feel his pain.

  • Report this Comment On March 30, 2013, at 4:36 PM, TimKnows wrote:

    Apple is a mess, don't even look at it for another $ 150 bucks down from here.

  • Report this Comment On March 30, 2013, at 6:59 PM, spakklal wrote:

    If you compare Apple to any other TECH Company which are over 200 Billion dollar in Market Cap, Apple has better Profit Margin, their products does get a premium then any of their Competitors. Apple had tremendous growth in the last 5 years and I believe that their Sales will double in the next 5 years by adding many more products in different Sectors of the Economy like Energy, Healthcare, Transportation.

  • Report this Comment On March 30, 2013, at 7:01 PM, demodave wrote:

    Dan, you are citing Rocco Pendola as an authority on Apple: you completely discredit yourself. Why waste the rest of the keyboard strikes?

    "Apple says it is a software company". Of course it is. The software sells the hardware! They did make the mistake of briefly licensing their software, but thankfully stopped that. The software keeps the customer happily sucked-in to the ecosystem. The industrial design is good, don't gt me wrong, but it's the software and the easy transition of content from one box to the next that keeps the system going.

    Given the expected growth in the markets that Apple created on a consumer level (touch-screen phones/tablets), Apple's returning/recurring revenue is enough to more than justify its former high of $700.

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