Apple(AAPL)’s 1Q13 earnings

the report

After the close yesterday AAPL announced its 1Q13 earnings results (the company’s fiscal year ends in October).  AAPL earned $13.81 per share on revenues of $54.5 billion, both all-time records.  Sales were up 18% year on year, EPS were down by $.06.  EPS exceeded the Wall Street consensus by a little.  Revenues were a tiny bit lower.

Note that 1Q13 had 13 weeks in it, 1Q12 had 14.  On an apples to apples basis, sales would have been up by about 25% and eps would have shown a gain of 10%+, I think.

new guidance

AAPL also announced it was changing the way it would give forward-looking earnings guidance–and provided the first figures using the new method.  Under Steve Jobs, the company gave what inevitably proved ludicrously low single-number suggestions about what its sales, margins and EPS for the following quarter would be.  I’m not positive AAPL intended its “guidance” to be funny, but the process ended up being almost a parody of the way most other companies proceed.  My strong impression is that AAPL knew the figures it suggested were wildly inaccurate.

Under Tim Cook, AAPL has decided to become a bit more conventional.  During the conference call the CFO said that 2Q13 revenue will likely be $41 billion – $43 billion.  Gross margin will be between 37.5% and 38.5%, operating expenses $3.8 billion – $3.9 billion.  Other income will be about $350 million and the tax rate will be around 26%.  Unlike the past, no EPS figure was given.

All that would imply EPS of around $10 for 2Q13–a figure substantially below the brokerage house consensus of $11.50.  Of course, until we have actuals to compare with we won’t know whether the new company guidance protocol is intended to be any more accurate than the old.

Nothing on the call thrilled Wall Street.  As I’m writing this in mid-afternoon, AAPL shares are down about 12% in an otherwise flat market.

details

The iPhone is fine.  Units were up 29% yoy (30%+, apples to apples), revenues up 28%.   iPhone 5 was capacity constrained for most of the quarter, iPhone 4 for the entire period.  So sales could have been higher.  Despite this, sales were in line with the growth of the smartphone industry. Remember, too, that smartphones are AAPL’s main business, comprising 60% of revenues and more than 2/3 of operating profit.  So this is the business that counts.

two points of weakness

Macs (10% of sales)

AAPL was capacity constrained with new iMacs.  AAPL’s PC unit volume was down 22% yoy (-15% is probably a better apples to apples number), in a market that declined by 6%, however. So having more iMacs on the shelves would have affected the degree of market underperformance, not the fact.   Higher unit selling prices meant that revenue declined by about 10% ata.

iPads (20% of sales)

Units were up 48% yoy (60% ata). That’s good.   But revenues were up only 22% (30%? ata).  That’s bad.

Yoy the average selling price of iPads in total (minis, iPad 2s and the newest models) dropped from $568 in 1Q12 to $467 during 1Q13.  In other words, during the year AAPL saw a massive move away from its flagship tablet offering toward cheaper models.  My back of the envelope guess is that the company sold around 13 million newest model iPads during the 2011 holiday season   …and only about half as many this time around.

Significance?

A while ago, AAPL decided to move its computer line upmarket.  My guess is that it’s now suffering from a cyclical falloff in demand caused by macroeconomic weakness–and made somewhat worse by the high price points.

The iPad numbers say to me that the tablet market is already quickly evolving away from the original high profit margin format of the original iPad, either toward a $400 price point for corporate/ education use and a $200-$300 price for consumers.  If I’m correct, the tablet market may end up being much bigger than previously thought, but it won’t follow anything like the high profit trajectory of the smartphone.  Note, too, that mini production was capacity constrained during the quarter.  The average unit price might have even been lower if AAPL had been able to satisfy all its potential mini customers.

my take

The tablet numbers are the only disturbing thing I found in the APPL quarterly information.  From what I’ve read, I’m not sure anyone else has noticed, however.  But both in tablets and Macs, AAPL has given the first hints that even it can be subject to business cycle forces.  That’s another way of saying that the company’s peak earnings acceleration phase may be behind it.

From a stock market point of view, however, investors have been discounting the arrival of this day (incorrectly, until now) for a half-decade.  AAPL has $137 billion in cash, about a third of its market capitalization, and no debt.  If we assume the company can earn $50 a share this year, it’s trading a 9x earnings, while growing at a bit less than 15% in weak economic times.  Better economic times should move that growth rate north.  Ex cash, AAPL shares are trading at 6x.  That’s crazy low.

where will the buyers come from?

I’ve read somewhere recently that over 3/4 of all equity mutual funds in the US have AAPL as one of their top few positions.  Equity oriented hedge funds have been up to their ears in the stock for a long time.

Two reasons why:

–it’s been a great stock to own for almost ten years, and

–at its peak, AAPL represented 10% of the IT sector’s market cap and 5% of the S&P 500’s.  Therefore, any professional concerned with outperforming an index would be forced to establish at least a market weighting in the stock in his portfolio, if for no other reason than to protect himself from losing ground to a surging AAPL stock price.

So, who’s left to buy?  No one.

What I’ve just written sounds pretty stupid, but it’s a situation that occurs often in smaller markets where one or two stocks dominate the index.  We just haven’t seen it in the US during my lifetime.

A common strategy in these markets is to neutralize the whales (have a market weighting) and try to achieve outperformance elsewhere. So virtually everyone already owns all the stock he ever intends to own.   The result is that surprisingly small amounts of buying and selling can move the giants a long way.

This may be happening with AAPL.  Certainly, in my opinion, the fundamentals don’t warrant the current low price.  But it’s anyone’s guess how long the current malaise may last.

going ex-growth: the (most times) arduous trip from growth stock to value stock

growth stocks

Growth stock investors are dreamers.  They try to find stocks that will grow faster than the consensus expects, for longer than the consensus expects.

As a good growth stock reports surprisingly good earnings results, the stock price typically rises.  Two causes:

–the stock adjusts up for the better earnings; and

–expectations for future growth rise, leading to price earnings multiple expansion.

If, for example, the stock is trading at 15x expected year-ahead earnings before the report, after the report it may end up trading at 18x the new, higher, level of expected earnings.

At some point, this explosive upward force becomes spent.  The reason may be technological change, or maybe new competition, or maybe the market for the company’s products is completely saturated  (a fuller discussion).  As this happens, the supercharged upward path I’ve just described begins to go into reverse.  The company reports disappointing earnings.  The stock moves downward to reflect new, lower, earnings expectations, and the price earnings multiple contracts.

Today’s question:  how/when does this negative process stop?

It’s important to realize that professional growth stock investors have seen this movie of mayhem and destruction many times before.  They know the plot lines well.  There may initially be some doubt about exactly when the downturn is commencing.  But growth investors know that how they sell a stock is the most crucial determinant of their long-term performance.  So once they become convinced that the salad days are done, they’ll be quick to sell.

The initial buyers will likely be non-professionals who see a decline as a chance to buy a stock they’ve heard about from the financial press or from friends and which appears on the surface to be less expensive than it previously was.   Or they may be members of the growing class of professional traders, many of them associated with hedge funds, who are not particularly interested in company fundamentals, but who buy and sell for short-term profits, either “reading” stock price charts or using their “feel” for the rhythms of the markets to make their decisions.  Eventually both groups also figure out the bloom is off the rose.  In my experience, the traders sell to cut their losses; the non-professionals continue to hang on.

The eventual home for former high-fliers is with value investors, who specialize in companies with flaws where the stock has been beaten down in an excess of negative emotion.  Typically, value investors use computer screens to identify the lowest, say, quintile of the market measured by price/cash flow or price/book value.  That will be the universe they study more closely to make their stock selections.  Many times, these stocks will be in highly business cycle-sensitive industries,  or ones that show little growth.  Companies may be laggards in their industries, either because of poor management or other fixable problems.  Value investors typically say that they buy $1 worth of assets/earnings for $.30 and sell it at $.80.

The point is it usually takes a long period of time, and enormous deterioration of a growth stock’s fundamentals, before the fallen angel sinks low enough to catch the value stock investor’s attention.  Also, like their growth stock counterparts, value investors have industries that they have studied carefully for years and which constitute their comfort zone.  The two areas of familiarity are pretty close to mutually exclusive.  So it may take an extremely cheap price for a value investor to take the risk of buying, say, a tech company instead of a presumably safer–or at least better understood–cement plant, auto parts maker or steel mill.

As I’ve written many times before, the one exception to this pattern that I’ve seen is AAPL, whose price earnings deterioration began five years or more ago (depending on how you count) despite continuing explosive earnings gains.  In fact, at present, AAPL shares are trading at a 25% discount to the market median PE multiple, according to Value Line.  True, there are qualitative signs that AAPL’s growth heyday may already be in the rear view mirror.  But the market’s bad treatment of the stock seems excessive to me.  Price action after the upcoming earnings report will be instructive.

more thoughts on Intel (INTC)

reaction to INTC’s 4Q12

I’ve been reading financial commentary on the INTC 4Q12 results.  Analysts seem to fall into two camps:  one thinks that the stock declined by 6%+ because the 4Q report confirms the secular demise of the PC industry; the other thinks the earnings were, for one reason or other, disappointing.  I don’t think either is right.

As to the earnings, fourth quarters are always tricky to figure.  Companies apportion costs quarter by quarter during their financial year on a pro rata basis given their projections of full-year results.  4Q is a kind of residual quarter when all sorts of final adjustments are made to the accounts, so that the quarterly numbers total to the full-year actuals.   It’s impossible for outsiders to figure out in advance what these adjustments may be.  In addition to these “usual” difficulties, in the INTC case we also knew there would be plant and equipment writeoffs + startup costs to be factored in.

In other words, the idea that the consensus Wall Street estimate for 4Q would be accurate had to be taken with a heavy grain of salt.  INTC beat it handily, anyway.

The decline of the PC story has been with us for some time.  It may also be true, especially in the developed world.  But I think the situation is more complex than is typically portrayed.  Cyclical economic weakness is certainly playing some role in lackluster sales, especially in emerging markets, where a PC is a major consumer expenditure.  In addition, the major sellers of PCs in the US, Dell and HP, make machines that are ugly, clunky and unreliable.  Both are gradually being displaced by Asian manufacturers like Asus and Acer, I think, but that won’t happen overnight.  In other words, evaluating the global PC market from the state of the US, which most analysts do, is probably a mistake.

Personally I’m keeping an open mind about the “demise” story.  But since I think the assumption that it’s correct is already heavily discounted in INTC’s current price, I don’t think “demise” is a reason to sell the stock.

what worries me

1.  As I understood the INTC story, 2012 was supposed to be a transition year for earnings, marked by peak R&D+ plant and equipment spending.  2013 was supposed to be the year when INTC began to cash in on this heavy investment.  Spending would recede, and INTC would be buoyed by its first significant participation in the cellphone and tablet markets.

Instead, we learned from the INTC earnings announcement that 2013 will see higher investment on R&D and P&E than 2013.   I’ve read from tech blogs that INTC chips tuned for Windows tablets may not be available until September.  Cellphones, according to the company, are a 2014 story, at best.

In other words, the reemergence of INTC as a cutting-edge chip supplier to the post-PC world has been pushed back a year.

2.  During its conference call, the company said it had plenty of money to “defend” the dividend, which I take to be an assurance that the current payout won’t be cut.  Also, even though the company’s stock spent a good part of November and December either right around, or below, the $20 a share level, this weakness didn’t cause INTC to accelerate its share repurchase program.  It ended up buying its typical $1 billion worth of stock, at an average price of $21.20.

Neither of these items may mean anything.  Still, to me they suggest that INTC is thinking its coffers aren’t as bottomless as they might previously have thought and that it has to husband its cash.

3. In its earnings report, INTC presented its current situation, in my view, as something everyone should be fully aware of.  I wasn’t, though.  And the sharp decline in the share price since the call suggests to me that I wasn’t alone.

Although this may be a minor point, I suspect that INTC has a very old-fashioned view of investor relations–thinking that talking to a small group of sell-side analysts means it is reaching the investment community at large.  That model certainly worked when I entered the business thirty years ago.  It’s next to useless today, however.  Odd for a tech company, too, to deliberately dress itself up in old-fashioned clothes.

The result is continuing surprises to investors–and probably a PE multiple a point lower than it would be if INTC embraced the 21st century–or even the late 20th.

my bottom line

I think of INTC as a bit like DIS–a firm where a dynamic new management team has been shaking up a mature business that had become complacent and was gradually losing its relevance.

INTC’s turnaround is taking longer, and is proving more expensive, than I had thought.  The 2H12 industrial slump hasn’t helped matters.

My expectation is that we’ll see an upturn in the PC business in the developing world during the next quarter or two.  The server business should follow suit.  By that time we’ll have more evidence about whether INTC can make any inroads into the tablet market.

For now, I’m content to hold the stock I own.

 

are political mists clearing in Washington?

The US securities markets are closed for Martin Luther King Day.  I’m going to make only a brief post–and one not as directly associated with finance as usual.

 

As a growth investor, I’m a big believer in progress through creative destruction.  I think the rate at which such change occurs accelerated during the Cold War period after WWII, and accelerated again when China decided to ditch central planning in favor of Western economics in the late 1970s.

Change isn’t easy.  The forces of the status quo–the current economic and political leaders–in every economy are very powerful.  They oppose change in any way they can, because it’s in their own economic interest to do so.   In the emerging world, crunch time typically comes when the supply of new workers for labor-intensive export-oriented manufacturing  (most often textile) is exhausted.  Wages begin to rise.  Operations become less profitable.

In theory, it’s clear what has to be done for the national good–migrate to higher value-added industries by worker retraining and by shifting government efforts toward creating infrastructure that attracts more sophisticated foreign companies willing to transfer technology.

In practice, the corporate and government beneficiaries of the way things are now use their clout to stop this from happening.   Many times, because they’re rich and powerful, they get their way–to the long-term detriment of the local economy.

In the developed world, the prime example of the dysfunctional triumph of the status quo over progress is Japan.  Once an incredibly dynamic economy, Japan has spent almost the past quarter century protecting the political and industrial establishment of the late 1980s.  The result has been decades without economic growth, an industrial base in shambles, a sharp decline in the Japanese standard of living and the piling up of an immense government debt.   Ugh!

To my mind, the EU has already traveled a significant way down the same path.

The US, although at an earlier stage,  appears to me to be following suit as well.  This despite the increasingly intense dissatisfaction of the electorate, expressed mostly as unhappiness with continuing deficit spending.

Pretty scary stuff.

Very recently, though, Washington appears to be having second thoughts about what it’s dong.  The Republicans are now saying they won’t repeat last year’s fight in Congress over increasing the debt ceiling.  The Democrats are saying they’ll prepare a budget that includes spending cuts.  So we may be seeing some willingness on both sides to give up their rigidly partisan, protect the status quo, positions.

Certainly, it’s very early days.  But what significance would a movement toward common sense and compromise in Washington have for stocks?  The world already knows that the dysfunction story ends in an economic disaster.  This possibility get expressed in investors paying  a lower price earnings multiple for US stocks than they otherwise would.

How much multiple expansion would a less self-destructive Washington engender?  One point?    …two?  Each point would represent about an 8% increase in the market level.  So there’s a lot at stake.

Intel’s 4Q12–waiting for the upturn

the report

Yesterday afternoon, INTC reported earnings results for 4Q and full year 2012.  For the quarter, INTC made $.51 per share on revenue of $13.5 billion.  Revenues were down 3% year-on-year, and flat sequentially during a normally seasonally strong quarter.   EPS were off 24% vs. 4Q11.  The profit figures were considerably better, however, than the Wall Street analysts’ consensus of $.45.

For the full year 2012, INTC’s revenues were down by 1% yoy, at $53.3 billion.  EPS were down by 10%, at $2.24.

INTC also gave initial guidance for 2013 yesterday–basically for a not much more than flattish year, with considerably better performance during the second half than in the first.

The stock rose initially as traders saw the better than expected quarterly EPS, only to fall by 5% then they read down the page to the 2013 guidance.  As I’m writing this on Friday morning, INTC shares are down more than 6%.

the details

INTC’s overall business began to decelerate in the second half.  Weakness continued through 4Q.

As worldwide economic growth slowed, corporations responded by cutting spending on servers and PCs.  PC demand from individuals in emerging markets, who had been pillars of strength through the first half, began to sag as well.  Cloud computing everywhere and servers in China were exceptions to this trend.  Weakness was especially acute at the bottom of the PC market.

INTC’s customers spent 4Q working down the inventories of PCs, especially Windows 7 machines, that they already had on hand, rather than buying lots more chips from INTC and making new ones.  Knowing this was likely to happen, INTC shuttered some older production lines earlier than expected and using many of the machines to accelerate development of state-of-the-art 14 nm chips.  These moves (which I think were the right things to do) created one-time changes that whacked 5.5 percentage points from INTC’s gross margin during the quarter (plant writeoffs + startup expenses), clipping about $.10 a share from EPS.

where to from here?

INTC expects an improving world economy to give a boost to its general corporate server business and to its burgeoning PC business in emerging economies as 2013 progresses.

The company also thinks that the personal computing market among affluent individual customers will bifurcate into a large smartphone/7″ tablet market and a second one, consisting of 10″ and larger devices.  It thinks the latter market–ultrabooks, convertibles, tablets–will demand the full speed and computing power of traditional PCs, but in increasingly lighter, thinner, less power-hungry forms   …and that INTC chips will be the only ones able to satisfy these needs.  The first proof of this thesis will likely come late this year.

Significant cellphone market penetration will be a 2014 story, at the earliest.

paid to wait?

That’s the Wall Street cliché about poor-performing high-dividend stocks–that you’re being “paid to wait” for good things to happen.  In the INTC case, I’m content for now to do so.

I must admit, though, that I had expected the good news to be, if not knocking at the door, at least to be walking up the street toward my house, by now.  I don’t think INTC management did much to disabuse me of that view, either.  I don’t mean to say that they misled me;  rather, I suspect this is turning out to be a much longer haul than they expected, too.

Having said that, INTC shares are for me becoming the kind of uncomfortable question that every professional portfolio manager has to deal with sooner or later.  On the one hand, every time you trade you think you know more than the people on the other side of the bargain.  This is somewhat delusional because, on the other hand, experience shows that even Hall of Fame players are wrong at least four times out of ten.

One thing I’ve learned over the years is that if my brain is telling me one thing and the charts are telling me another, the worst decision I can make is to add to a full position (which is what INTC is for me).  The next worst would be to have INTC be one of my two or three largest positions (it isn’t).  So I’m going to sit on my hands for now.