Apple's Unrelenting Mac Attack On The PC Market

In Apple's most recent fiscal year ended in September, the company's Macintosh line of personal computers generated revenue of $21.783 billion, representing 20.12% of Apple's $108.249 billion in reported revenue. The Mac's $4.304 billion gain in revenue during the fiscal year represented 10% of Apple's $43 billion in revenue growth. 

Although the $21.783 billion in revenue generated from Mac sales in FY 2011 represented only 20.12% of the company's revenue total, it exceeded Apple's total reported revenue of $19.315 billion in FY 2006, just five years before. In FY 2011, revenue generated from Mac sales exceeded the revenue generated from iPad sales by $1.425 billion. 

Apple's Unrelenting Mac Attack On The PC Market

The graphs and table data in this article illustrate and delineate Apple's unrelenting Mac attack on the PC market. For over five consecutive years the rate of growth in Mac unit sales has exceeded the rate of unit sales growth for the PC industry as a whole. In only one quarter of the most recent twelve fiscal quarters has Apple experienced a year-over-year unit sales decline. In FY 2011 Macintosh unit sales rose about 22.5% to 16.735 million units following a 31% rise in unit sales in FY 2010. 

In the current quarter ending in December, Macintosh unit sales may reach 5 million units for the first time in the company's history, breaking the unit sales record of 4.894 million units sold in the recent September quarter. 

Apple Price Target: $640 Per Share

Today I am posting my 12-month price target for Apple of $640 per share. This target price forecasts a 63% advance in the share price within twelve months and tracks slightly below my anticipated 66% growth in earnings per share in Apple's current fiscal year. 

Apple's Share Price Today

Apple closed trading on Friday, October 21st, at $392.87. At that price the shares traded at 14.19 times trailing 12-month earnings of $27.68 per share. The lowly price-earnings multiple stands in stark contrast to the company's 66% revenue growth in the fiscal year ended last month and the corresponding 82.7% growth in earnings per share. At the end of the fiscal year, Apple had cash and marketable securities of $81.57 billion or almost $87 in cash standing behind each outstanding share. The company's cash per share provides a strong foundation for share price appreciation at a rate in tandem with the anticipated rate of growth in earnings per share.

Apple's languid September quarter revenue growth of 39% and eps growth of 52% reversed the recent upward momentum in the share price.  While the quarter's outcome was indicative of Apple's revenue growth challenges in fiscal quarters immediately preceding the annual iPhone product refresh, it was not indicative of anticipated average rates of revenue and earnings growth in the four fiscal quarters immediately ahead.

The Cyclical Nature of Apple's Revenue and Earnings Growth

Each of Apple's four fiscal quarters have strong seasonal or product cycle influences on their respective revenue and earnings growth outcomes. For example, the current fiscal quarter (FQ1 2012) includes a fourteenth shipping week that occurs once every six years and encompasses the immediate post-Christmas shopping week. The quarter will also realize above average rates of revenue and earnings growth due to the release of the iPhone 4S early in the quarter. While FQ4 2011 was negatively impacted by the pending iPhone model refresh, the current quarter will benefit from the release of the new iPhone handset. 

Apple 12-Month Price Target

There were a number of challenges revealed in Apple's September quarter results I will address later in this column. Those challenges are amplified by a slow-growth global economy and increasing competition in the smartphone device market. Based on Apple's FY 2011 performance, anticipated global growth in iPad sales and the successful launch of the iPhone 4S, I've established a 12-month price target of $640 per share. 

This 12-month price target of $640 anticipates FY 2012 revenue growth of 55% and eps growth of 66%. It also anticipates a price-earnings multiple of no more than 14 times forecast FY 2012 earnings of $46 per share. 

Apple's Share Price Performance

The chart and table data below illustrate and detail Apple's share price performance over the most recent twenty months. It includes the share price as of Friday, October 21, 2011 and the closing share price on the first trading day of the month following the release of earnings dating back to February 1, 2010.

Spaceship Apple Comes Down To Earth

Apple's September results were below most expectations. The $28.27 billion in revenue represented a $300 million sequential decline and a comparatively languid 39% year-over-year gain. On earnings per share, the 52% year-over-year rise to $7.05 was far below the 96.2% rate of eps growth realized over the first nine months of the fiscal year.

The Good News In The September Quarter

Mac Unit Sales: If there's good news to be found in the September quarter results it's the 26% growth in Mac unit sales against a global PC market with diminished prospects for continuing growth. In addition to strong unit sales growth, revenue from Mac sales rose 29%. 

Asia-Pacific: The Asia-Pacific region (exclusive of Japan) turned in a 139% increase in revenue. Although the September quarter's pace of revenue growth was below the rates of growth in the region realized in the previous two fiscal quarters (down from 247% growth in the June quarter), China is Apple's most important growth market at this point in time. Asia-Pacific's $6.53 billion revenue contribution represented 23.1% of Apple's total revenue in the period.

Apple's December Quarter Guidance: Management has guided to revenue of $37 billion or 38.4% revenue growth and eps of $9.30 or growth of 44.6% over the December quarter one year before. But keep in mind December quarter 2011 (FQ1 2012) includes an additional shipping week that occurs once ever six years to better align fiscal quarters with calendar quarters. The unusual 14th week is the week immediately after Christmas. Absent the additional shipping week, guidance would have been more conservative and it moves a high revenue week away from the following quarter. 

The Not-So-Good News In The September Quarter

Retail Stores: Despite a 25% increase in Mac unit sales at the stores in the September quarter and the first fiscal quarter in which the retail stores sold over 1 million Macs, overall store revenue rose only 1%. Apple ended the quarter with 357 stores open for business and new stores were opened in the fiscal period. This 1% revenue rise includes the revenue activity of new stores opened within the past year. Retail store traffic and revenue growth remain heavily influenced by seasonal factors and Apple product refresh cycles. 

iPhone Sales: Management stated during the conference call with analysts that September unit sales were materially impacted by a drop-off in demand ahead of the release of  the new iPhone 4S handset. iPhone unit sales growth remains heavily dependent on the company's product refresh cycle. The 16% sequential drop in unit sales is in light of surging global smartphone demand and the meager 21% year-over-year gain in unit sales is against a prior-year period in which Apple ended the quarter with constrained supplies of the then latest handset. Although Apple reported outsized unit sales growth for the iPhone of 142% in the June quarter, both Asia-Pacific and the Verizon agreement were big factors in that gain. 

The Apple Analyst Sandbag Factor

Each fiscal quarter Apple 2.0's Philip Elmer-DeWitt provides an index of quarterly estimates that include numbers from a select group of bloggers and numbers from Wall Street pros. For the September quarter, the differences in the estimates from the bloggers and the pros have the widest divergence since the quarterly indexes began. This quarter the gap is so pronounced it might best be described as a chasm. Revenue estimates range from a high of $37.19 billion from Mark Beauch of the AAPL Independent Analysts group to a low of $26.36 billion from Morgan Stanley's Kathryn Hubert. On earnings per share, the estimates range from a high of $10.01 put forward by this author to a low of $6.30 also from Kathryn Huberty. 

The table below lists the average revenue and eps estimates from the 16 bloggers and the 28 pros who submitted revenue and eps numbers. 

The Apple Analyst Sandbag Factor

There's more to the difference in the average eps estimates from the two groups than the difference in revenue estimates. This difference is what I call "The Apple Analyst Sandbag Factor."

The purpose of this exercise is to remove differences in the revenue estimates from the numbers submitted by the individual analysts and compare each analyst's eps outcome to their respective revenue estimate, using Apple's June quarter results as a constant in the review. The outcome of the analysis indicates the Wall Street analysts are forecasting a significant deterioration in Apple's net income and eps performance per revenue dollar based on their own revenue and eps numbers. This anticipated deterioration in net income and eps performance represents the "Sandbag Factor."

The chart below lists the September quarter estimates from the analysts. The content is courtesy of Apple 2.0 and is from the article titled, Wall Street Still Doesn't Understand Apple published on October 11, 2011. The analysts are ranked by revenue estimate. The bloggers are highlighted in green and the Wall Street pros are highlighted in blue.

Why Apple's FQ4 Earnings Will Approach $10 Per Share

There's no other company on the planet that excites the imagination of its product users as much as Apple. In developing revenue and earnings estimates for the company, I am guided by one overarching principle:

Apple doesn't sell products. Apple crafts customer relationships and those relationships sell Apple products. 

Understanding Apple's Pathways To Success
Understanding Apple's pathways to success requires more than an effort at counting the number of individual products that might be sold. It necessitates understanding the company's eco-systems and what motivates enterprises and consumers to invest in the purchase of Apple-branded products. 

My analysis relies heavily on the company's historical growth trends and an evaluation of the phenomena that occur when appealing and abundant content is made readily available for smartly designed devices. These products are offered to customers who have established a relationship with Apple through iTunes, through visits to the company's retail stores or have a long-standing relationship with the company through the use of Apple's popular Macintosh line of personal computers. 

Below are my estimates for the company's September quarter and an overview of the elements that underly the assumption Apple's FQ4 earnings will approach $10 per share:

	Revenue Segment		Units FQ4 ’11	Units FQ4 ’10	Unit Growth	FQ4 Revenue
	Macintosh		4,500,000	3,885,000	15.83%	5,737,500,000
	iPhone		26,500,000	14,102,000	87.92%	17,225,000,000
	iPod		7,250,000	9,051,000	-19.90%	1,268,750,000
	iPad		14,500,000	4,188,000	246.23%	9,425,000,000
	Peripherals					620,000,000
	Software, Services					800,000,000
	Other Music					1,625,000,000
	Revenue Total					36,701,250,000
	Cost of Sales		58.20%			-21,360,127,500
	Gross Margin		41.80%			15,341,122,500
	Operating Expenses		8.79%			-3,225,000,000
	Operating Income					12,116,122,500
	Other Income					200,000,000
	Income Before Taxes					12,316,122,500
	Provision For Taxes		23.50%			-2,894,000,000
	Net Income					9,422,122,500
	Earnings Per Share		(Based on 940.825 million shares)			10.01

The AAPL Independent Analysts FQ4 Estimate Index

On October 18th Apple will announce results for the company's 4th fiscal quarter ended September 24th. To gauge expectations for the quarter, we asked members of the AAPL Independent Analysts group on Linkedin and members of the Apple Finance Board who have participated in prior quarterly indexes to submit estimates of the company's 4th fiscal quarter performance. 

Among the fourteen individuals who submitted estimates for this September quarter index are well known independent analysts Horace Dediu and Daniel Tello, returning analysts Navin Nagrani and Patrick Smellie and newcomers Michael Cranston and Martin Epstein. Collectively these individuals represent a cross section of the AAPL independent analyst community and come from various professional backgrounds and career interests. 

On average index participants anticipate the following September quarter unit sales results:

	Macs	4,677,500			20.40% YOY Rise
	iPhones	23,765,071			68.52% YOY Rise
	iPods	7,158,857			20.91% YOY Decline
	iPads	13,624,214			225.32% YOY Rise

Notes on the Unit Sales Numbers:

Mac sales: Over the first nine months of FY 2011, Macintosh unit sales rose 21.1%. The index average is inline with the recent unit sales trend and reflects confidence in Mac sales during the recent back-to-school season.

iPhone sales: The index average reflects expectations of a slower rate of growth in iPhone unit sales in the 4th quarter due to the release of the iPhone 5 in the holiday quarter. During the first nine months of the fiscal year iPhone unit sales rose 113%. 

iPod sales: The Apple iPod remains in a state of steady unit sales decline. The iOS-based Apple iPod touch remains the biggest revenue generator among the available iPod models. Apple's decision this year to offer $100 in iTunes content to students purchasing a new Mac versus a free iPod touch will influence iPod unit sales results in the quarter. 

iPad sales: The index average suggests anticipation of strong iPad unit sales in the September quarter as Apple strived to resolve the challenge of constrained product supplies. Index participants expect a rise in unit sales of 225% over the prior-year period.