Why I'm Bullish on Apple

Over the past several weeks I've focused much of my analysis work on the performance elements that underpin Apple's extraordinary rates of revenue and earnings growth. Meanwhile, Apple's share price (AAPL) has been trapped in a comparatively narrow and underwhelming trading range since the all-time high of $364.90 was set in intraday activity on February 16th of this year.  

There's much speculation why Apple is currently trading, even after today's strong advance, almost 5% off the all time high at Tuesday's closing price of $347.83 per share. From index rebalancing to hedge fund ploys, most active AAPL traders have their own views as to the factors impacting the share price. But none of these factors in any way impact the company's fundamental strengths nor limit the long-term potential of the share price. I consider AAPL's current trading price to represent a short-term dip below an established trading range prior to a strong, bullish advance. 

The Factors Supporting AAPL Share Price Appreciation

Rising Revenue, Rising Earnings Per Share: Apple remains in an era of extraordinary revenue and earnings growth. During the first six months of FY 2011 Apple's revenue and earnings growth rates have accelerated due to the popularity of the Apple iPad and the continuing success of the Apple iPhone. In the first six months of FY 2011 Apple's revenue rose 76.2% and eps moved higher by 83.2%. Constraints on iPad 2 supplies in the March quarter limited the revenue and earnings growth rate from moving even higher. 

For FY2011 (ending in late September) I forecast Apple's revenue will reach or exceed $112 billion and eps will reach at least $27.50 per share. Based on my forecasts Apple is currently trading at a multiple of only 12.65 times the current fiscal year eps estimate. The revenue growth chart, including my FY 2011 revenue estimate, illustrates the pace of Apple's revenue growth over a six-year period. Over 60% of Apple's revenue in FY 2011 will be sourced from products that did not exist in the marketplace as recently as four years ago today. The markets for the Apple iPhone and especially the Apple iPad have yet to be fully realized and the markets for both products will continue to expand. 

Even more dramatic than the pace of revenue growth is the pace of growth in earnings per share. Form eps of $1.55 in FY 2005 to estimated eps of $27.50 in FY 2011.

No matter the continuing rise in the diluted share count, the pace of growth in earnings per share continues to outstrip the pace of growth in revenue due to the reduction in the percentage of revenue consumed by operating expenses and the reduction in the percentage of revenue consumed by all major other cost components. 

The chart below illustrates the increasing percentage of each revenue dollar that flowed to the net income line over the past 10 fiscal quarters.

iPhone Unit Sales Continue To Rise: On May 8th I published a 10-quarter review of Apple's unit sales by product line. Below is a graph that illustrates the pace of growth in iPhone unit sales over the most recent 10-quarter period. 

The Apple iPhone is Apple's undisputed revenue leader and in the March quarter unit sales rose 113% on a global basis and 155% domestically due in part to the device's availability on the Verizon network. In the domestic market smartphones are primarily purchased on postpaid, subsidized contracts. The impact of the Verizon deal will benefit iPhone unit sales for the foreseeable future. Most Verizon customers interested in the Apple iPhone were unwinding existing contracts at the end of the March quarter. iPhone unit sales have risen 99.5% in the first six months of FY 2011, surpassing the average 91% unit sales gain experienced in the prior fiscal year. The pace of iPhone unit sales is accelerating as the iPhone becomes available to Verizon customers and Apple continues to open new international markets for the device. For the first six months of the fiscal year revenue generated from iPhone sales represented 44.3% of Apple's $51.04 billion in reported revenue. In the March quarter iPhone sales represent almost 50% of reported revenue. The outcome of iPhone sales in the final six months of the fiscal year will be the biggest determiner of Apple's revenue and earnings growth in the fiscal year. 


Macintosh Unit Sales Continue To Rise: Although the Mac has continued to be overshadowed by the success of the Apple iPhone and the emergence of the Apple iPad, the Macintosh has continued to succeed in the era of handheld devices.

The Macintosh line of personal computers has outperformed the overall PC industry for 20 consecutive quarters. In FY 2010 Mac unit sales rose about 31.5%. During the first six months of FY 2011 unit sales have grown 25.2% and the iMac line was updated in May. For the six month period revenue from Mac sales represented just over 20% of reported revenue. While the percentage contribution from the Mac line to total revenue has diminished since the release of the Apple iPhone in 2007, the success of the Mac continues to play an important role in Apple's revenue and earnings performance. Each Mac sold on average has roughly twice the revenue weight of each iPhone sold. 

Apple Is A Global Retailer: On February 5th I published a post titled Apple Retail Stores: Macintosh Sales Center and More. Since the release of the Apple iPad in April 2010, retail store revenue growth has outpaced the rate of revenue growth for the company as whole. The March quarter was the 2nd consecutive quarter in which Apple retail store revenue rose 90% or more in prior-year comparisons. According to management, 50% of Macs purchased at Apple's retail store locations are sold to consumers who have not owned a Mac before. The mutual benefit to retail store sales and iPad unit sales can be easily seen in the numbers. Apple is the only major digital device maker with a global chain of retail stores. The retail margin on store sales (over $1 billion in the December quarter) creates its own net income growth. 

The Apple iPad: Outside of the Apple iPad there currently isn't a consumer market for tablet devices. That may change and may change relatively soon, but not before the end of CY 2011 and the important holiday quarter. In an April survey by Gartner, Inc., the research company suggests Apple's iOS-based iPad will dominate the tablet market through 2015.  

The iPad is an expansion of Apple's iOS multi-device product paradigm. The depth and array of content available for the iPad and the ability to share content among Apple's handheld devices creates not only a mutual halo effect supporting product sales, it places Apple among the largest software distributors in the world. In the March quarter Apple iPad sales represented 11.5% of reported revenue. By FQ1 2012 (the December quarter) the iPad's revenue contribution may top 25% of the company's reported revenue total. 

Content Sell Devices: If there's an axiom that Apple has proven to be true it's that content sells devices. Apple now services over 200 million iTunes accounts backed by credit cards and has been selling content for handheld devices since the opening of the iTunes music store in 2003. 

The explosive growth in iPod sales that started in 2003 and the acceleration of the pace of growth iPhone sales in 2008 following the opening of the Apple App Store have demonstrated that content is key to device sales. The Apple App Store now hosts over 500,000 titles and the company is the world's largest distributor of music. Apple's leadership position in music and app sales and distribution is a decided competitive advantage. The fact that music, movies and apps can be shared among Apple devices will continue to attract not only new customers to the company's product paradigm, it entices current customers to purchase additional Apple devices. 

iCloud

Earlier today Apple announced Steve Jobs will present the keynote address at the company's annual World Wide Developers Conference scheduled to open next week. The focus of this year's week-long event is the next commercial iteration of Mac OS X for the company's Macintosh personal computers and the next version of iOS for the company's handheld digital devices. It's also expected Apple will unveil new services under the iCloud moniker. 

What separates Apple from its competitors in each of the company's product markets is the monetization of hardware and the commoditization of software and content. Apple's ability to maintain pricing control on hardware devices differentiates the company from virtually all competitors. This is the antithesis of the Microsoft revenue model that monetized software at the expense of hardware commoditization. New services provided by Apple must be viewed by the manner in which they will fuel hardware device sales, encourage retail store visits and extend the mutual halo effect among Apple's hardware devices. 

No matter the rise in the share price today from the encouraging news Steve Jobs will deliver the keynote address at WWDC and the company will more aggressively enter the market for cloud-based services, it's hardware device sales that deliver the company's extraordinary revenue and earnings growth performance. 

Conclusions: I expect Apple's revenue in FY 2011 (ending in September) to reach or exceed $112 billion representing at least 72% revenue growth in year-over-year comparison and for earnings per share to meet or exceed $27.50 representing at least 82% growth in eps this fiscal year. While there's wide and varied speculation as to why Apple's share is trading at about a 5% discount to the all-time high reached in mid-February, the company's rates of revenue and eps growth will remain strong and relatively consistent for the balance of the fiscal year. FY 2012 will also be a year of strong revenue and eps growth due to continuing expansion of the iPhone's international sales regions and the forthcoming product refresh. Apple will maintain its commanding position in the emerging tablet market through at least the next fiscal year with new retail store openings in previously underserved international markets buttressing revenue and earnings growth.

I'm bullish on Apple and expect a 70% rise in the share price over the next 12 months as the 3rd and 4th fiscal quarter revenue and earnings performances confirm the current growth track. Currently trading at about 12.65 times expected fiscal year earnings per share, the shares are undervalued relative to the expected earnings performance. I maintain a 12-month price target of $590 per share. Although overall market conditions have slowed the pace of the share price advance, the company's revenue and earnings growth rates and the strength of the company's financial position will deliver strong share price gains over the next four fiscal quarters. I will update my interim price targets over the next week. 

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The objective of the Posts At Eventide web presence is to benefit readers seeking to understand Apple's financial performance and to serve as a repository of information and analysis for other independent AAPL analysts preparing quarterly estimates and share price forecasts. Please see the Posts At Eventide Resource Guide for more information. 

Robert Paul Leitao