Apple: A Buy On the Sell-Off

Apple  (NASDAQ: AAPL  )  had a reasonably good quarter with its earnings beating estimates, but the company's earnings report led to a big sell-off. In terms of revenue,  Apple had its biggest quarter ever, but the company's weak revenue forecast for the first quarter of calendar year, 2014 coupled with lower iPhone unit sales, sparked the sell-off.

The market reaction is a little overblown primarily because Apple sold record iPhone units and generated record revenues from the iPhone franchise. And Apple's quarterly earnings per share hit an all-time high as well. Apple's EPS increased 5% to $14.50, partially driven by share repurchases by the company. Apple's revenues from China Mobile  (NYSE: CHL  )  will surprise to the upside because of conservative guidance by Apple's management. And the pullback in Apple shares represents a great buying opportunity. 

iPhone prices on the rise
In the holiday quarter, the average selling prices (ASPs) of the iPhone surged sequentially to $637 from $577 in the previous quarter. The increase in selling prices of the iPhone is likely due to the higher mix of iPhone 5s unit sales relative to the iPhone 5c. And this strength in iPhone 5s unit sales has enabled the company to preserve its gross margin at 37.9%, ahead of the company's guidance.

With 56% of total Apple revenues coming from the iPhone franchise, the segment is crucial for the company's growth. Apple's iPhone unit sales did reach record levels to the tune of 51 million iPhones in the holiday quarter. However, this fell short of expectations that were pegged at roughly 56 million units. Total iPhone revenues grew 6% year over year to $32.5 billion. In 2013, Apple's market share of the worldwide smartphone market stood at 15.3% and Samsung stood at 31.3%, according to IDC. 

Apple's performance in North America was disappointing with sales portraying a slight decline, and management pointed toward supply constraints for the iPhone 5s and a lack of demand for the iPhone 5c. The lack of growth in North America is leading many investors to question the company's ability to grow its handset business in the region. However, in the U.S. smartphone market iPhone holds roughly 41% of smartphone subscribers at the end of November and iPhone users have a loyalty rate of 90%, according to data from comScore and Kantar.

And Apple's revenues did grow 11% year over year to $4.9 billion in Japan driven by the company's deal with NTT Docomo. And according to Kantar, the iPhone holds 69% share of the smartphone market in Japan.

The major pessimism surrounding the company's sell-off after the earnings report was that the company guided toward revenues which are essentially flat from the prior year, even though the company's marquee deal with China Mobile will start showing up in the company's financials in the current quarter.

Investors and analysts alike expect the China Mobile deal will provide tailwinds for Apple's March quarter, because of China Mobile's subscriber list of more than 760 million. However, it is worth worth noting Apple will initially sell iPhones in only 16 cities where China Mobile offers 4G. In the future, China Mobile will be rolling out 4G stations in more than 340 cities across China, and these cities will eventually become new addressable markets for Apple.

Robust iPad sales
Apple's iPad unit sales also hit a record in the holiday quarter with more than 26 million units. And iPad ASPs stayed relatively stable from last quarter to $440. The strong growth in iPad unit sales was aided by stellar unit sales in China, where sales doubled.  

Consumers are relishing the newly introduced iPad Air and iPad Mini with the Retina Display. The iPad has a strong position in the U.S. commercial tablet market with 78% share, according to IDC. Apple sold 4.8 million Macs in the last quarter and ASPs stood at $1322 in the last quarter.

The tablet market grew 28% in the last quarter, and Apple now holds 33.8% market share across the globe, according to IDC. Apple's market leading position in the tablet market should lead to more revenues as the company turns to more emerging markets for additional revenue growth.

Enterprise market could be big
According to IDC, the iPhone now holds 59% market share of the commercial smartphone market in the U.S. And this should rise in the future as the company's iOS 7 platform received a security clearance from the U.S. federal govt. Apple continues to invest heavily in R&D, both in existing product categories as well as in new product development, and this should aid in better serving enterprise customers.

Corporations are increasingly leaning toward Apple products. Tim Cook disclosed in the earnings call that the iPhone is being used at 97% of the Fortune 500, and the iPad is being used at 98% of the Fortune 500. So, increasingly, Apple is addressing the enterprise market.

Going forward
Apple's revenue guidance has been weak, but there is a probability that the company's guidance was overly conservative. The company's China Mobile deal should provide more upside in the current quarter. Apple's revenues from the iTunes ecosystem have grown 19% in the last quarter and now have an annualized run-rate of $17.6 billion.

Consumers can buy content on Apple's platform using the Touch ID on the iPhone 5s, and this should aid in growing services revenue as well. Apple's share repurchase plan should fuel more EPS growth in the near future. The dip in Apple shares represents a great buying opportunity before the China Mobile upside comes to full fruition.

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  • Report this Comment On January 31, 2014, at 6:16 AM, innovatedilemma wrote:

    Good layout of the facts. AAPL isn't growing, but it isn't shrinking either (though this is what the bearish argument expects). The rise in price of the iPhone signals that there is still demand at the high end. According to Cook's comments on the CC, the 5C really held back the 5S in the States and kept AAPL's numbers down. Hopefully, AAPL has learned its lesson: don't listen to Wall Street! It was the one that wanted a cheaper phone and AAPL tried to oblige. Big mistake.

    Curiously, AAPL is also doing everything it can to hold back earnings. AAPL is now going on 11 billion in deferred revenues. Those revenues and the profits they bring will be booked later this year. AAPL should be able to gain at least 2-3 dollars in EPS value out of those earnings.

    Finally, let's not forget the 800 lb. elephant in the room: free cash flow. AAPL paid $7.7 billion in dividends and buyback and was still able to increase its cash pile from 146 billion to 159 billion. Astounding. That's more money than GOOG makes in an entire year.

    Patience is the operative word right now. The same patience MSFT investors buying at $20 a few years ago had to have.

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