When analyst Gene Munster of Piper Jaffray, a renowned bull of tech giant Apple (AAPL +0.10%), 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.
