The invitations have been sent. Apple (NASDAQ: AAPL ) will host an event on Oct. 22, when it is widely expected to unveil its next-generation iPads. As the company's second-largest product line by revenue (18% of total revenue), the refresh prompts an important question: Will the new lineup provide incremental upside in Apple's bottom line? Or is Apple doomed to tough comparisons, and the law of large numbers?
Trading at just 10 times next year's earnings estimates, Apple isn't priced for growth. In fact, all Apple needs to do to provide a decent return for investors buying at $500 (assuming price follows fundamentals over the long haul) is to maintain current levels of profitability. The company's generous share repurchase program combined with a growing 2.3% dividend yield should take care of the rest. In Apple's case, however, maintaining makes for a difficult task. Maintaining, when you are already the world's most valuable publicly traded company and the industry's most profitable player, is quite an accomplishment.
Apple is already struggling to compete against its year-ago self. No wonder Apple's priced so conservatively. Year-over-year revenue growth rates are decelerating and year-over-year EPS is declining.
And Apple's iPad segment seems to be part of the problem. In the company's most recent quarter, iPad revenue was down 27% from the year-ago quarter. Even worse, the product line's profitability is suffering. Though Apple doesn't report operating income by product segment, Apple CEO Tim Cook said during its 2012 fourth-quarter earnings call that the iPad Mini's profit margin is "significantly below our corporate average."
But there's hope
You just need to zoom out. In the three quarters leading up to last quarter, Apple posted unit shipment growth in its iPad segment in excess of 25% every quarter, reaching year-over-year growth of 65% just one quarter ago.
Even more, on a quarter-by-quarter basis, Apple investors should expect major fluctuations in year-over-year comps -- especially in Apple's iPad segment. This year's launch schedule doesn't compare well with last year's schedule at all. Last year, the most recent refresh to the iPad lineup was in March, making the lineup just about three months old by the beginning of the third quarter of 2012. This year, however, the last refresh to Apple's iPad lineup was on Nov. 2, 2012, making the product line nearly eight months old when the third quarter began -- a huge difference.
Going forward, comps for the tablet segment should be easier. First, while the fourth quarter of 2012 had an old lineup of iPads, the fourth quarter of 2013 will have a fresh one. And going into the fiscal 2014, Apple's iPad comps will no longer be up against the higher average selling price of an iPad lineup without the lower-priced, lower-margin iPad Mini. Not only will this make revenue comps for the segment easier, but it also means that the segment's incremental contribution to the bottom line will more closely align with revenue growth as opposed to trailing it.
Last, Apple hasn't arguably had a formidable product in the fast-growing sub-8-inch category yet. Apple's first-generation iPad Mini used the A5, a processor that dates back to the iPad 2. Even more, the device didn't even have an HD display -- a significant handicap when compared to 7-inch competition over at Amazon, Google, and Samsung. The rumored iPad Mini to be launched on Oct. 22 addresses these issues. If current speculation holds true, the tablet will sport Apple's latest A7 processor and boast a Retina display.
There's still growth left for Apple
At least there is in its iPad segment. A more competitive lineup and easier comps give Apple's second-largest segment a solid shot at providing incremental upside to the bottom line over the next four quarters. Assuming the rest of Apple's business holds up, therefore, 2014 iPad sales could help Apple get back to EPS growth.
Is Apple's impressive profitability sustainable over the long haul?
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