[ARTICLE] Apple seems headed for a second-half sales bonanza. Its forthcoming iPhone 6, expected in late summer or fall, will no doubt feature a handful of new gee-whiz capabilities. But its biggest selling point is likely to fix an Apple shortcoming. The current iPhone is popular, but its four-inch display can cause feelings of inadequacy when viewed next to a five-incher from Samsung Electronics. The iPhone 6 is sure to come in a bigger size, whether its 4.7 or 5.5 inches, or somewhere between the two. It will give the iPhone faithful their biggest reason to upgrade in years—and perhaps even lure back some defectors. Thats good news for shareholders. One recent analysis suggests the new iPhone launch could add 10%-15% of earnings upside later this year. That should rekindle interest in Apple shares, which now trade at a deep discount to the market. Look for a gain of 20% over the next year, not counting dividends. Apple is the U.S.s largest company, with a stock market value of $471 billion. In the current fiscal year, which runs through September, iPhones are expected to bring in 54% of sales; iPads, 19%; and Mac computers, mostly notebooks, 12%. Wall Street expects overall sales to total $181.4 billion, a 6% increase. Thats not bad growth for a behemoth—unless you compare it with Apples numbers from a few years ago, before everyone and their Aunt Maude had a smartphone. Over three years ended in September 2012, Apples sales quadrupled. The bear case for Apple comes in two main forms. Theres the victim-of-its-own-success argument: Apples current markets look saturated, and its combination of high selling prices and 38% gross margins make it a target. And rumored new product categories, like televisions and watches, just dont seem to promise enough profit oomph. Theres also the Steve-would-have-done-this-better argument, most recently covered in a book released this past week, Haunted Empire: Apple After Steve Jobs, by Yukari Iwatani Kane, a former Wall Street Journal technology reporter. Following the death of Apple co-founder Jobs in 2011, and his replacement as CEO by Tim Cook, Apple has become more bureaucratic, less innovative, and less intense, Kane argues. The bull case is summarized in a response to the book from Cook, e-mailed to CNBC: Apple has over 85,000 employees that come to work each day to do their best work, to create the worlds best products.…Weve always had many doubters in our history. They only make us stronger. Apples scale indeed allows it to invest in research and drive down manufacturing costs to a degree matched only by Samsung, and theres plenty of room for both companies to prosper, as they swap the lead now and then on product specs. Its a mistake, however, to think of Apple as just a hit-driven gadget maker. APPLES BUSINESS MODEL more closely resembles what analysts have taken to calling hardware-as-a-service. The iPhone at any given moment might not lead the pack on spec-sheet items, like camera megapixels and chip speed. But those who buy the hardware get excellent software with continuing upgrades, which can add more to phone enjoyment than incremental technical gains. They get the ecosystem, including a giant app store and slick music, movie, and photo programs. They get the Apple retail stores, which offer access to service and repairs. And many Apple features like Siri, its voice-recognition program, and iTunes Radio, a free music-streaming service, benefit from a network effect that makes them better as more people use them. In fiscal 2013, Apples nonhardware businesses brought in $16 billion in revenue, up 25%, with an estimated gross profit margin of 33%. Not all of the services are big profit producers, but together they give Apple sticky customer relationships, with a device retention rate of about 90%, and create an annuity of hardware sales, according to UBS analyst Steven Milunovich. Thats not to say Apple can ignore shifting hardware tastes. Its biggest product miscue in recent years has been the lack of a larger screen, according to Brian Marshall, an analyst with broker ISI. Blame Cook if you like, but at least he took the iPhone to four inches; previous models were 3.5 inches. Marshall predicts Apple will launch two phones this summer with screens measuring 4.7 and 5.5 inches. Others have predicted a fall launch. Rumor Websites, like AppleInsider and MacRumors, are packed with new feature leaks—educated guesses, largely. The iPhone 6 is sure to have a better camera, likely to have a stronger screen, and could possibly feature new sensors for things like health and weather. And perhaps there will be a watch that will work with the phone for fitness tracking. But one thing just about everyone expects, including analysts who watch suppliers, is a bigger display. The iPhone has a massive base of 260 million users, and it already takes the place of many things consumers used to buy separately. Steve Cichon, a Buffalo, N.Y., blogger and iPhone user, had a hit post in January titled, Everything from 1991 Radio Shack ad I now do with my phone. The newspaper clipping pictured had a computer, camcorder, mobile and home phones, voice recorder, clock radio, stereo, CD player, and more, costing thousands of dollars in total. Early iPhone upgrades brought must-have features, including leaps in processing and downloading speeds to make use better use of all the features. Recent phones are fast enough. And a recent RadioShack flier devoted much of the cover to smartphones, a tablet, and earbuds, suggesting few remaining categories for the iPhone to kill. THE PERCENTAGE OF iPHONE users who upgrade each quarter recently dropped to about 9%, from 10%-11% in 2011 and 2012, according to Marshall. In peak quarters, it has reached 12%-14%. The rate should be similar to peak quarters if not better later this year, such is the pent-up demand for larger iPhones. Strong iPhone 6 sales could add more than $3 a share in earnings upside during Apples quarters ending in September and December, Marshall reckons. Street estimates have the company earning just under $25 a share in those two quarters combined. Beyond larger screens, two other factors suggest a bright second half for Apple. Products presented at the Mobile World Congress in Barcelona in late February showed maturity in the high-end smartphone market and a lack of innovation in top Android models, according to Canaccord Genuity analyst T. Michael Walkley. That suggests Apple will face relatively muted competition when its larger phones make their debut. It could also get a boost from fierce competition among U.S. wireless carriers. Analysts say new early-upgrade plans, which allow for more-frequent phone purchases, are gaining momentum as two-year phone contracts expire. Dont expect Apple to return to blazing growth. Wall Street expects earnings to rise 3% this fiscal year, to $38.2 billion, and earnings per share to rise 8%, to $42.76. Next year, EPS are expected to rise another 8%. But shares are priced for handsome returns from here. They go for 12 times the calendar-2014 earnings estimate, versus 16 times for the Standard & Poors 500 index. The company holds $159 billion in cash and investments, equal to a third of its stock market value. Subtract that, and shares go for just eight times earnings. Its unclear what Apple has planned for all that money. I think theres a good chance of a special payout, says Barbara Marcin, who manages the Gabelli Dividend Growth fund. On March 4, Apple announced the coming retirement of its chief financial officer and the appointment of a new one, Luca Maestri, who has a reputation for shareholder friendliness, according to Cantor Fitzgerald analyst Brian White. We would not be surprised if a larger buyback and higher cash dividend are announced around the companys…earnings report in April, he wrote in a March 5 note to investors. The current dividend yield is 2.3%. Last quarter, Apple spent nearly twice as much on stock repurchases as on dividends. Barrons recently cautioned readers that many companies appear to be spending richly on shares at elevated valuations, which can backfire for investors (Hey, Big Spender! Jan. 27). But Apples modest valuation suggests its buybacks are beneficial. Todays tech investors are paying huge premiums for companies perceived to have fast growth potential, and little for the rest. Apples discount seems too large. It surely doesnt deserve to trade at Facebooks valuation of 53 times earnings, or even a third of that. But if Microsoft fetches 14.4 times the calendar 2014 earnings consensus, a 20% rise for Apple over the next year seems plausible. That would put shares at about $635, or 13.6 times the calendar-2015 earnings forecast. E-mail: editors@barrons
Posted on: Sun, 23 Mar 2014 11:42:06 +0000
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