03 December, 2008

Apple's holiday quarter shackled by Good problems, high iPod demand

When Steve Jobs came on Apple's (AAPL) conference call the last go-round it was designed to put analysts and investors at ease. That it did, his presence calmed questioning and glossed over a then shockingly broad and conservative forecast for the holidays: Earnings of between $1.05 and the $1.30s per share of Cupertino fruit.

Introducing the Non-GAAP method for earnings was equally brilliant and needed, as analysts couldn't shake their traditional valuation methods of the company. The curve ball thrown by the iPhone's subscription accounting led to steady devaluation of the company stock, which then was taken brutally by the whirlwind of economic turmoil alongside the market. Bullish Cross (Link) did some of the most notable work recreating Apple's earnings for FY2008 putting "actual" earnings at around $7.50 vs the $5.36 reported in the standard GAAP way. A difference of over $2/share in earnings and about $40/share in price at a P/E of 20.

However, this subscription method which undervalued the company tremendously during the early stages of the Bears, will help propel the company forward in the troublesome economics that exist today. Steve's worker zealots could completely take the holiday months off and still count 1/8th of a year and half of the incredible selling iPhone revenues and earnings. But Apple folk aren't taking any time off and the expanding retail chain will be busier than ever this Christmas. Unfortunately it appears some of the company estimators forgot 2 important facts when placing Christmas build orders.

1) Apple products are hotter than ever and
2) People buy iPods as gifts no matter what

According to some work by long time Apple researcher Shaw Wu, Apple's experiencing wide shortages on iPods of all shapes and sizes. While analyst work can fall into several quality categories, most notably the work done by Gene Munster is always carefully calculated, checking shipping lead times on several web sites just doesn't qualify as ground-breaking research. It does however provide a simple barometer for demand if the sites you're checking happen to be some of the biggest in America (Sites like Amazon.com, Best Buy and Wal-Mart). As an aside, Wu, has been a constant on the Apple analyst providing reports to clients almost constantly.

When these retailers are showing shortages of select colour/storage combinations and long shipping times of other models it does qualify as cause for concern. Did Apple ship pessimistically along the lines of its forecast? Did it simply underestimate strong demand for its ubiquitous music players?

I believe the answer lies somewhere in the middle. Apple is being incredibly prudent in its cost controls these days, and after revealing to the world its new line-up of MacBook and MacBook Pro laptops and their new all-aluminum design process the R&D costs are aplenty. Couple this with the on-going work on the next version of its operating system OS X Snow Leopard, which is expected in early-mid 2009, iPhone/iPod Touch continuous software updates and whatever surprises are in store for MacWorl 2009 in January and some cost prudence is almost a necessity.

The company may have overshot it though in assuming current economic conditions would make the $230-$400 iPod Touch a tough sell. The reality is that the "Funnest iPod Ever" is performing exceptionally well and there are several reasons for it. Apple's online store has plenty of stock and has the Touch as a top seller. The App Store however, is near the top of the list if not at its peak of reasons to get the Touch. The Software marketplace pushed heavily by the iPhone in all adverts is also on and available for all iPod Touch devices, making the device far more than an iPod. As for the other models, iPod Nanos and Shuffles continue to make a great stocking stuffer year after year.

Amazon.com's list of top selling MP3 players is dominated by Apple, currently holding the top 10 spots, and 15 of the top 16. Dominance like this is incredibly hard to achieve, and even harder to maintain, as Apple has now done for the last several years. So with that research in hand, Wu's estimates call for 21Million iPod units to be sold, a little short of last year's record of over 22Million, but nonetheless a very successful holiday given current economics. Given the premise of over 20Million iPods, driven primarily by iPod Nano and iPod Touch devices, the logical thing for analysts to do would be to project a very healthy stream of iPod related revenue and earnings in the quarter.

Analyst conclusions on iPhone sales also represent the type of growth the company saw in the early years of the iPod rise. Last year's 2Million+ unit number is expected to nearly triple through the combination of in-store activations and iPhone specific gift cards. Corresponding AppStore sales will also be ready to incline in step, thus its safe to say the phone division is on solid ground for 2009. If China ever gets works out, the addressable iPhone market could potentially growth by another 600Million users.

So, all that's left for Apple to do is to prove the new Mac portables are as popular as they've started out being and you've got a company that will spend another conference call giving each other "corporate-speak" high fives, trying to step around analyst typical questions on how Apple bucked all these devastating economic head-winds. Year ago earnings of $1.76/share seemed so far away during the conference call and its accompanying guidance. With these latest analyst reports there is plenty of room for the consensus estimate to move higher.

The Vegas Line stands at $1.46 and I expect it to move to the 1.50-1.60 range as Jolly Saint Nick nears.

Disclosure: Author is long AAPL

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