The Oppenheimer Code, Fiscal Q1 2014, Part 5: (UPDATED) Checking up on Analyst Expectations for Fiscal Q1 and Q2 2014

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In case you’d like to refer back, click the following links for Part 1Part 2Part 3 and Part 4 of the current, fiscal Q1 2014 edition of my Oppenheimer Code home gamer earnings preview series.

My Oppenheimer Code posts for the prior two fiscal quarters are now collected in the Earnings Previews + Archive section.

NOTE:  As a friendly reminder/disclaimer, this isn’t treatise-level or expert-level stuff, not even close.  Just one person’s exceedingly humble attempt to gain a bit more insight into Apple’s fundamentals.  This isn’t “forest from the trees” – it’s even higher up in the iClouds.  More expert AAPL fundamentals types need not read on.

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(Advance TL;DR warning.)

For the third quarter in a row, we reach the final part of my Oppenheimer Code series – the WS expectations game.  And the stakes are higher than ever.

Sure, Wall Street will still pay attention to December quarter results – it’s always a blockbuster quarter, and Apple’s forever under the scanning electron microscope, after all.  But the advent of the China Mobile deal has likely shifted attention towards Apple’s March quarter guidance more than any prior March quarter.

Time to consult Yahoo! Finance once again to get an idea of analyst expectations.

Analyst Consensus Estimates for Fiscal Q1 2014 (a.k.a. the “Turn Card”)

For the December quarter, as of January 25, 2014 (two days to go before the earnings release), analysts polled by Yahoo! Finance are expecting Apple to report $57.46B in revenues (about 5.4% YOY revenue growth from $54.51B in the year-ago quarter) and $14.09 EPS on average (vs. $13.81 in the year-ago quarter).  (Reminder: Numbers are subject to continuous revision by analysts and this data disappears shortly after earnings, though you can compare against Thomson First Call estimates after that point, since they’re always cited by financial reporters.)

That does represent a decent jump in consensus revenue estimate from the $55.47B or so analysts were looking for as of three months ago, if I remember correctly…then again, $57.46B is still “safely” within Oppenheimer’s guided range of $55B-$58B.  (Of course, many analysts are looking for a revenue beat this quarter, which isn’t “a sure thing” under Apple’s still-fairly-new guidance methodology.)

EPS, in my opinion, should actually be decently easy to calculate this quarter.  Using the net income guidance data we already have (over at Part 1 of the series, which I’ve linked to at the top of the page if you need to refer back), implied EPS guidance @ 898M shares is $12.95 – 14.41, give or take a penny. Meanwhile, the Yahoo! Finance “analyst group” EPS expectation of $14.09 on average is up 27 cents from the late-October consensus estimate of $13.82.  Not as much of a percentage jump relative to revenue, it seems – then again, analysts probably aren’t convinced that Apple’s gross margins are rebounding yet (and in fairness, gross margins probably remain near multi-year lows and all, though the new increased deferrals are a large part of that).

Similar to what I wrote last quarter, there isn’t much room for “error” under guidance parameters, but Oppenheimer got the job done, as it were.  There’s a little bit of room for “upside surprise” even if Apple “merely” reports results at the top end of guidance.

There is a new “twist” in Oppenheimer’s guidance methodology as of October – it does “allow” for a net income beat, though of course EPS is a somewhat different matter thanks to analysts and home gamers alike having to guess that for themselves now.  Apple’s net income guidance topped out at $7.34B for fiscal Q4 2013 (the September 2013 quarter) – as it turns out, Apple brought in $7.512B in net income that quarter, the first time Apple’s results exceeded guidance under the current guidance system.  Hey, nothing wrong with a genuine net income beat – while buybacks have obviously helped AAPL big time, they’re always the less-preferred choice to boost EPS.

Apple/Oppenheimer issued a highly unusual guidance revision (both because of the 8-K filing and because it didn’t really revise anything) last quarter – but not this one.  There wasn’t any significant, negative supply chain or demand chatter reported as to iPhone from what little I could tell, and iPad, though supply-constrained, did cut down ship times fairly quickly.  

So, does Apple’s “silence” necessarily mean anything about the numbers it’s close to announcing?  We’ll know in about two weeks.

Analyst Consensus Estimates for Fiscal Q2 2014 (a.k.a. the “River Card”) (TL;DR WARNING)

China Mobile.  Need I say more?

Well, I happen to think Apple would’ve done pretty well even without China Mobile for the foreseeable future, but as you could tell from the CNBC interview recently, Tim Cook sees enormous potential in the new partnership.

Let’s move right to analyst expectations for the March quarter.  As of two days before earnings, analysts polled by Yahoo! Finance expect Apple to ring in $46.05B in revs and $10.93 in EPS.

Here’s the actual results and profitability/EPS metrics from fiscal Q2 2013:

REVENUES revs units ASP
iPhone 22955000000 37430000 613.27
iPad 8746000000 19477000 449.04
Mac 5447000000 3952000 1378.29
iPod 962000000 5630000 170.87
iTunes/software 4114000000
Accessories 1379000000
Total revs $43.603B
METRICS
Revs 43603000000 GM 37.50%
COGS 27254000000 OpEx Ratio 8.69%
Gross Margin 16349000000 Tax Rate 26.02%
Total OpEx $3.791B EPS $10.09
OI&E 347000000 # shares 946035000
year-ago shares 944893000
Inc before tax 12905000000
YOY share creep 0.12%
Tax provision 3358000000
net inc ratio 0.218952824
Net Income $9.547B

Hmm.  Well, analysts collectively see Apple increasing revenues about 5.6% YOY as of now, and for EPS to increase about 8.3%.  For some context, assuming Apple’s share count remains static from Q1 2014 to Q2 2014 at an estimated 898M, that represents an approximately 5% decrease in shares outstanding (which, assuming static net income, results in an EPS increase of about 5.3% if my math is right).

So when you think about it…5.6% YOY revenue growth…EPS that implies a consensus net income growth expectation of, say, 3% or so YOY growth…

You know what?  It’s not the most imposing consensus expectation in the world. 

Of course, there’s always catches.  And there have been some significant boosts in analyst estimates…one such analyst boosting his revenue estimate by about $2.7 billion.

There’s a mitigating factor in play, though, from a perhaps-unexpected corner.  That would be Tim Cook himself.  He was effusive about the new partnership with China Mobile, and dropped hints about “deeper collaboration” with the mega-carrier.   He certainly doesn’t seem to mind the news reports about “millions” of China Mobile iPhone orders or preorders, and sat side by side with Xi Guohua as China Mobile’s Chairman, via a presumably accurate translation, also mentioned “millions of preorders” for the TD-LTE iPhone.

So now the cat’s out of the sandbag, to mix my metaphors.  And that leaves Oppenheimer with considerably less cover of uncertainty when he issues guidance in a little less than two weeks, at least as far as China Mobile itself is concerned.

Could Oppenheimer issue range guidance that encompasses $46B or so by a comfortable margin of an extra billion or two?  Just like last quarter, I’ll go over what I think are the most important elements for the March quarter – iPhone, iPad, Mac, and the bolded metrics of gross margin, OpEx, and net income.

iPhone revenue

As I’ve theorized before, iPhone 5 was a likely disappointment for Apple (although 20% YOY unit growth for the entire iPhone line in fiscal 2013 isn’t exactly failure).

iPhone 5S, at least, seems to be off to a very impressive start.  I’m not exactly sure what it is with the 5S that people like “more” than iPhone 5…though as a 5 and 5S owner I can attest that the 5S is better in every single way, and Touch ID works extremely well with the exception of a strange Twitter bug.  But hey, whatever works.  Maybe it’s that “S generation effect” in play that propelled the iPhone 4S (which was, like the 5, a very fine iPhone).

Even if iPhone 5C is “underperforming” – we should get some comment from Tim Cook about that during the upcoming conference call, since he does address some of the media “hot topics” (such as supply chain rumors) – Apple still has the 4S, which is a profound upgrade from the surprisingly popular iPhone 4 last product cycle, albeit still tethered to the soon-to-be-obsolete Dock Connector.

Things get pretty interesting right off the bat from a compare standpoint, because iPhone had its worst YOY growth quarter ever (on a GAAP sell-in basis; sell-through was better) in fiscal Q2 2013.  iPhones sold increased from 35.064M to “only” 37.430M, representing just 6.7% growth YOY.

Assuming Greater China iPhone unit sales are flat YOY before adding in China Mobile – and China Mobile is able to sell 2 million more iPhones than its subscribers were “responsible for” buying new in the March 2013 quarter (whatever that number is), that’s 5.3% unit growth before factoring in the rest of the world.  It’s possible that March quarter demand for iPhone is lower due to the “early” launch in September, so I’m also assuming a decently conservative China Mobile first-quarter sales number to balance things out.

Will the rest of the world deliver iPhone growth YOY in fiscal Q2 2014?  Oppenheimer will almost certainly clue us in.  NTT DoCoMo should help…iPhone has never been a YOY decline in unit sales…then again, indirect data points like Verizon, which may or may not suggest an overall smartphone growth slowdown in the US, have to be kept in mind, even though one data point doesn’t extrapolate all that well.

So, how about “ASP”?  New deferral accounting will hurt slightly (there’s an increased deferral of $5, which I’d previously mistakenly thought was $10).  The bigger question is overall iPhone “ASP” trending.  iPhones used to sell with ASPs in the mid-$600s.  The year-ago ASP compare is $613.  Will something like an “S generation effect” benefit iPhone ASP in fiscal 2014 as well?  I think so, but who knows?  Well, here’s the “good” news – in iPhone 5’s last quarter (fiscal Q4 2013), ASP was an all-time low (if memory serves) of $577.  It seems like a lot, considering how long ASP was hovering above $600, but it’s only a 6.2% difference (make it an adjusted 7% now with the deferral increase).  And I’m guessing the popularity of the 5S will at least significantly narrow the $41 (with higher deferral) gap in ASP.  Obviously, the December quarter ASP number will provide a major clue.

iPad revenue

iPad is the riddle for March.  First, a little background/recap.

Somewhere along the way, iPad hit a “growth wall” of sorts.

As I tweeted the other day, iPhone units grew 73% YOY in fiscal 2012, with iPad “not much better” at 80%.

In fiscal 2013, iPhone grew 20% YOY, and iPad 22%.  That’s…kind of lockstep.  Whatever happened to the halcyon days of mega-growth for iPad?

Of course, iPhones and iPads play in very different markets.  Everyone “needs” a mobile handset, and the megatrend mix-shift of handsets towards smartphones continues.  iPads are Post-PC, and “less necessary” (or at least, lower-volume) than a communication/computing/Internet-connected ultrapocketable.  Meanwhile, those “light truck” PCs aren’t exactly going anywhere, even as they’re perceived to be going out of style.  If they’re still getting all of those dollars, it’d seem tablets will experience some growth slowdown due to the competition for buyers’ wallets.

Still, something about the iPad growth narrative seems a bit concerning near-term.  iPhone plays in a market with epic potential, but it’s also a more mature product line (that increasingly prices itself out of the market each passing year, to hear some naysayers tell it).  iPad plays in a smaller market, but it was once the harbinger of the tablet revolution.  And there are some signs that the tablet growth rate is being significantly boosted (read: skewed) by all-too-many analytics firms’  inclusion of “tablets” in the category which, while certainly cheaper, can’t hold a candle to iPad 1 (or Galaxy Tab) in overall versatility and usability.  (Examples here and here.)  Translation: If the “$199 and under” tablets are growth drivers, is the tablet market of “true” post-PCs really as full of potential as we were initially led to believe?

There’s also the “issue” of whether iPads, which start at $399/$499 for the most modern versions, are somehow “too expensive” in light of the countless other brands that “compete” with iPad on price, usually equipped with a version of Android, be it stock, customized, or forked.

To be clear, I’m not thinking iPad is in “decline” – Apple sure doesn’t.  And with the iPad lineup better and more diverse than ever, it’s not much of a stretch to predict a return to YOY growth as opposed to previous quarters.  But it would certainly be reassuring to see what I presume will be two consecutive quarters of  solid YOY growth for December and March – say, at least 15-20% on average.

Unlike iPhone, this isn’t a situation where ASP will be a headwind, at least to in my humble opinion.  ASP was $449 in fiscal Q2 2013, and I’ve commented on iPad’s likely ASP bounce for fiscal 2014 before.  The ASP compare actually seems “easy”!  But will iPad bring the units?  What kind of improvement over 19.477M iPads sold (fiscal Q2 2013) is in store?  Luckily, there’s a certain giant celco that will probably help with that before long.

Mac

Mac Pro is another big unknown for Apple.  It’s backordered – to FebruaryMarch!, but also brand-new, with all of the production ramp teething issues that come said newness, including a brand-new, apparently purpose-built factory in the US.  I’m not counting on Apple ever giving sales figures on its “trash can” Mac.

Let’s just assume for now that Mac may have been a 5-10% growth proposition (revenue and units) assuming nicely updated (iMac, 13″ retina MacBook Pro) and possibly redesigned (the 15″ retina MacBook Pro, MacBook Air, Mac mini?) Macs.  Mac Pros, of course, are no ordinary Macs.  The standard configs sell for $2999 and $3999 but there’s no way most buyers will stop there.  I don’t think it’s unreasonable to expect Mac Pro ASP to approach $4000 (or more) once users start tacking on graphics card, onboard storage, and even CPU custom-order options (I mean, why buy your Mac Pro and immediately do a processor swap yourself if you’re the average pro user in media, creative, education, business, etc.).

The March quarter represents a very interesting Mac inflection point for Apple, because Mac Pro is profoundly new, finally relevant again, and potentially worth three (or more!) of today’s Macs in revenue per unit (though there will be a subset of Mac buyers who move up from intended MacBook or iMac buys rather than being a “pure” incremental add).  Mac Pro is also likely a Power Mac-style margin leader among the Mac line.  I’m not ignoring the niche nature of the Mac Pro (will it even manage 100k units per quarter?), but it really won’t take many of them to positively impact Mac ASP and at least stabilize Mac margin.  This could be the year that the Mac makes a bit of a comeback.

Gross Margin

Check it out!  Finally, a gross margin compare Apple has a chance of at least matching, even with the increased deferrals – 37.5% in the year-ago March quarter.

And yet, I’m not so sure it “matters” as much as it has previously, just as long as Oppenheimer doesn’t guide GM to a range below, say, 35.5%-36.5% (with one of his explanations being a big YOY increase in deferred revenue given the new deferral rates).  As I mentioned above, I don’t think Wall Street will have any problem with significant YOY iPad growth “impacting” gross margin as long as revenue (read: iPhone) takes care of itself.

OpEx

That last section was actually quite short!  If my theory on OpEx is correctthis section could end this very sentence. 😀

Kidding aside, there isn’t too much to write at this point, given what I think is a forming (or should I say “solidifying”?) trend.  “Static” OpEx with lower sequential revenues will hurt profitability, but it’s not like Wall Street is expecting much net income growth YOY for the March quarter anyway (right now).  And hey, Apple faced this exact “problem” last fiscal year, so it’s nothing new.  Don’t forget that other “silver lining” – OpEx may turn out to be the easiest element of Apple’s income statement to account for, ever! 😀

Net Income, EPS and the Buyback Factor

Believe it or not, I’m projecting OpEx to be the biggest net income headwind for the March quarter, because it’s highly likely to outpace what I assume will be YOY revenue growth (look out below, AAPL longs – including me – if Apple can’t manage that).  When you’re a company still on progress towards $200B in annual revenues, a YOY OpEx increase of maybe 15% or so (my estimate) is much more likely to “hurt” the bottom line.

China Mobile is the absolutely enormous X-factor in all of this, of course.

Finally, as far as EPS and buybacks?  I’m thinking Apple is quite capable of posting another YOY increase in net income, particularly now that 760+ million China Mobile subscribers now have access to TD-LTE iPhones and, doubtless soon, TD-LTE iPads.  Which would be a very good thing for AAPL bulls.

Buybacks are kind of a mystery.  Apple initially “bought the dip” aggressively, borrowing $17B in its blockbuster bond issue, and now seems to be more “cautious”, seemingly buying up stock at a level that domestic cash generation allows, and not much beyond than that (ah, the joys of cash repatriation disincentives).  By my estimates, Apple “only” retired about 11M shares in the December quarter, which at average sales prices might’ve been $6B or so worth of stock (though that’s still well on pace to finish the current $50B buyback authorization before the end of calendar 2015). Is another bond issue on the way for Apple to “buy cheap(er)” before the current buyback program ends, or will Apple “coast” to the end of the program with domestic cash generation?  Who knows.  For now, I’m assuming Apple will repurchase less than 10M or so shares in the March quarter, at least until we get some clues after the earnings announcement.

This ends my Oppenheimer Code post series for fiscal Q1 2014.  Hope you found it a decent read!

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