Thursday, January 14, 1999
DJIA 9236.79 -112.77 (-1.21%) S&P 500 1227.74 -6.66 (-0.54%) Nasdaq 2313.98 -2.83 (-0.12%) Value Line Idx 927.02 -3.22 (-0.35%) 30-Year Bond 102 4/32 +11/32 5.11 Yld

An Investment Opinion
by Louis Corrigan

Apple Still a Bargain?

Shares of Apple Computer (Nasdaq: AAPL) fell $2 5/8 to $43 7/8 this morning following a better-than-expected Q1 earnings report. Excluding a one-time gain, earnings of $0.78 per share topped the consensus $0.70 estimate. Earnings in the seasonally strong September quarter had been $0.68 per share, so the company delivered a sequential gain as well as a crushing 136% advance over the year-ago period, when Apple rode the rollout of its G3 desktops to its first real turnaround quarter.

While today's selloff no doubt includes simple profit-taking, some analysts issued lukewarm reports. Salomon downgraded the shares based partly on fears that Apple had stuffed the retail channel to get to its unbelievable $25 million (two days) worth of inventory, down from $400 million a year ago and $78 million in the September quarter. PaineWebber complained that iMac sales, while strong at 519,000 units out of a total of 944,000 total units sold, were below the firm's aggressive target.

A larger concern is that Apple has picked the low-hanging fruit of Mac faithful looking for upgrades and that its long-term growth prospects are still sketchy. PaineWebber estimates that of 27 million total industry computer units shipped in the December quarter, Apple's share remains below 4%, or far from its 7%-8% share of the total installed base. Then there's valuation. Apple is currently benefiting from U.S. net operating loss carryforwards that should keep the tax rate at about 10% this year before returning to the mid 30% range next year. So the stock already sells at 22 to 24 times fully taxed earnings estimates for FY99.

CFO Fred Anderson did say that two days inventory was as good as it gets and that Apple's target is 4 to 6 days. Part of the massive inventory improvements, though, have come from systematic changes, including Apple's streamlined product strategy, its outsourcing of board production, and improvements in its supply chain, which should only get better given that the company installed an SAP enterprise system during the quarter that should help sales at the online store. The Internet store actually closed midway through December to complete that installation. Anderson said channel inventory was flat at 5 weeks and that all of the old iMacs still in the channel are price-protected (so without the price cut, gross margins would have been even higher). With channel stuffing, you usually see days sales outstanding rise, whereas they fell sequentially from 56 to 49. With 51 days sales payable, Apple operated this in Q1 with a negative cash conversion cycle a la Dell (Nasdaq: DELL).

While reported revenue grew just 8% to $1.7 billion, Apple ditched its printer and consumer/education monitor businesses in the past year. Revenue from computer systems actually increased 17%, quite a feat considering the drop in the average unit price from $2,400 last year to $1,840 in September to the current $1,776. Even backing out a 150 basis point one-time gain in gross margins from operating system software upgrades, gross margins were 26.7%, steady sequentially and up from 22.4% last year. As for the iMac, what's compelling to me is that some 32% of sales went to first-time computer buyers while 13% went to former Wintel customers. The iMac is expanding Apple's market -- massively. And both consumer portables and the important OS X operating system upgrade will be introduced later this year.

When valuing Apple, investors should work in a 36% tax rate. But they must also back out the $9.44 cash per share net of debt. If you assume about $2.00 per share in FY99 earnings, Apple's cash-adjusted price is now 17 times the forward estimate, in line with its revenue growth. No doubt, Apple faces continued challenges. Still, a long-term investor might see a company with a consumer-oriented brand and proprietary technology, a company that's regaining market share and delivering operational efficiencies that are tops in its industry. Such a company ought to trade at a premium both to the market and to its own growth rate. (A recording of Apple's conference call is available at 402-220-4030 through 6 p.m. Pacific Time today.)


Sunglass Hut International (Nasdaq: RAYS) flipped up $2 to $9 3/8 after it said it has acquired privately held shades.com, an Internet site devoted to selling branded nonprescription sunglasses, and SwissArmyDepot.com, which mainly peddles SwissArmy knives and watches, for roughly $2.8 million in cash and $1.2 million in a convertible subordinated note.

Micropositioning and precision optical products supplier Axsys Technologies (Nasdaq: AXYS) zoomed in on gains of $4 to $18 after the company received an unsolicited offer to be acquired for $20 per share in cash, about a 43% premium on yesterday's closing price. Chairman and CEO Stephen Bershad withdrew his Nov. 20 offer for the company, which was $5 per share below the new proposal.

Computer systems integration and maintenance services firm Unisys Corp. (NYSE: UIS) picked up $1 1/8 to $34 9/16 after turning in Q4 EPS of $0.42, $0.02 better than the Street's consensus and ahead of last year's $0.25 figure as well. The company continues its debt reduction efforts, today calling for the redemption of the outstanding $27 million of its 8 1/4% convertible subordinated notes due 2006 on March 15.

Retailer Dayton Hudson (NYSE: DH) targeted gains of $2 3/16 to $56 1/4 after it set a $1 billion stock buyback program to be completed within the next two years.

Online software retailer Egghead.com (Nasdaq: EGGS) hatched $1 3/4 to $24 1/2 following the company's announcement that it signed an agreement with @Home Network (Nasdaq: ATHM) to create an auction service for @Home along with Internet Shopping Network's First Auction. @Home took on $2 1/4 to $108 this morning.

Technical calculation and analytic software provider MathSoft Inc. (Nasdaq: MATH) added $1 5/16 to $6 after it announced a partnership with Amazon.com (Nasdaq: AMZN) allowing shoppers to select Amazon products on MathSoft's e-tailing site in exchange for mention on Amazon and a percentage of sales.

Internet software developer HomeCom Communications (Nasdaq: HCOM) hammered out gains of $ to $ on news that Houston-based data processing services provider Total/1 contracted HomeCom to build an exclusive version of its "Personal Internet Banker" for Total/1's customers.

Year 2000 specialist Accelr8 Technology Corp. (Nasdaq: ACLY) sped up $7/8 to $5 1/8 after it launched a "virtual year 2000 factory" on its website providing a self-test for companies seeking to gauge their readiness for the year 2000. Users can then contract with Accelr8 for related services.

Hotel room networking technology provider LodgeNet Entertainment (Nasdaq: LNET) moved ahead $15/16 to $8 7/16 after announcing a pact with Cendant (NYSE: CD) subsidiary Wingate Inns International to place LodgeNet's guestroom services -- including Internet access -- in nearly 12,000 of Wingate's rooms by year's end.

Boston-based equity investment firm Affiliated Managers Group (NYSE: AMG) won $1 1/16 to $27 3/4 after it said Q4 EPS will be above Wall Street's $0.29 consensus estimate by about 35% to 40% because of "performance fees at certain affiliates." The company expects to report earnings Jan. 27.

Telecom equipment company Advanced Fibre Communications (Nasdaq: AFCI) gained $1 3/8 to $13 after NationsBank Montgomery upgraded the stock to "buy" from a "hold" rating.

Technical, embedded, Web, e-commerce, and enterprise information systems software developer Rational Software Corp. (Nasdaq: RATL) moved up $4 1/4 to $30 13/16 on an upgrade to the "recommended list" from "market outperfrom" from Goldman Sachs.


Natural foods supermarket operator Whole Foods Market (Nasdaq: WFMI) fell $8 13/16 to $35 11/16 after the company said its direct store and general administrative expenses got "out of control temporarily" during the fiscal first quarter and will lead to EPS between $0.45 and $0.50. The company said analysts had been expecting EPS of $0.58 for the quarter. No less than six Wall Street firms lowered their ratings on the company this morning.

K-6 chip maker Advanced Micro Devices (NYSE: AMD) flopped $3 13/16 to $23 15/16 after reporting Q4 EPS of $0.15, up $0.06 from last year but $0.04 shy of the First Call mean estimate. Revenues increased 15% sequentially and 29% year-over-year to $788.8 million, which the company attributed exclusively to higher sales of its K-6-2 processors with 3DNow! technology. Disappointed, at least four brokerage houses downgraded the company.

Photographic film and products company Eastman Kodak (NYSE: EK) slid $6 3/4 to $71 15/16 after reporting Q4 EPS of $1.05 (excluding charges), which was $0.30 higher than a year ago but a dime short of the First Call mean estimate. Sales and earnings were hurt by "dramatic" slowdowns in the company's office imaging business and continuing financial problems in Russia. The company added that it expects "modest" sales growth in 1999. Archrival Fuji Photo Film (Nasdaq: FUJIY) rose $1 3/4 to $34 7/8 on Kodak's misfortune.

Enterprise resource planning (ERP) software firm J.D. Edwards & Co. (Nasdaq: JDEC) was decked for a $3 loss to $20 3/8 after Morgan Stanley Dean Witter lowered its rating to "outperform" from "strong buy."

Financial service application software developer Phoenix International Ltd. (Nasdaq: PHXX) blew up for a $4 5/8 loss to $10 after saying its fiscal Q4 EPS will come in between $0.08 and $0.10, missing the $0.20 the company said analysts had been expecting. For the year, EPS should be around $0.27 or $0.29, below the previous $0.39 estimate. The company blamed the shortfall on lower-than-expected revenues in Latin America and deferred contracts from clients in the U.S.

Oil and gas exploration and production company Snyder Oil Corp. (NYSE: SNY) was drilled for a $1 1/8 loss to $12 5/16 after agreeing to merge with larger rival Santa Fe Energy Resources (NYSE: SFR) in a stock swapped valued at $448 million, based on last night's closing prices. The companies expect to cut costs by $20 million during the first full year of operations by getting rid of duplicate overhead and combining their operations in the Gulf of Mexico. Santa Fe lost $9/16 to $6 this morning.

Web portal company Lycos Inc. (Nasdaq: LCOS) fell $6 5/8 to $90 5/16 after Deutsche Bank Securities cut its rating on the firm to "accumulate" from "buy."

Online health and wellness information publisher OnHealth Network Co. (Nasdaq: ONHN) dropped $5 3/8 to $13 1/8, giving back some of yesterday's 85% surge that was reportedly prompted by a mutual fund manager's positive comments about the company on CNBC.


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