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Stellar 1Q for Apple

After a sedate fourth quarter, Apple Inc. (AAPL) reported an outstanding first quarter 2012, which breezed past the Zacks Consensus Estimates. Apple earned $13.87 per share in the reported quarter, handily beating the Zacks Consensus Estimate of $10.07. Apple shares scaled new heights following the earnings release and increased approximately 7.3% to reach $451.08 in after hours trading.

Earnings per share (NYSEArca:EPS - News) soared 115.7% from $6.43 reported in the year-ago quarter and were also ahead of Apple’s conservative guidance of $9.30. Apple’s first quarter beat was primarily driven by strong holiday season sales based on the ramp in demand for the new iPhone 4S, which was released in October 2011. The company registered record iPhone and iPad sales during the quarter.

Revenues

Total revenue in the quarter surged 73.3% year over year to $46.33 billion and beat both the company’s forecast of $37.00 billion and the Zacks Consensus Estimate of $38.86 billion. The year-over-year upside was driven by strong growth in iPhone (up 133.0% year over year), iPad (up 99.0% year over year), and Macintosh (up 22.0% year over year) sales.

Product Highlights

Macintosh: Apple shipped 5.20 million Macintosh computers in the reported quarter, representing a 26.0% year-over-year increase, attributable to strong demand for Macs across all geographic regions, particularly in the Asia-Pacific region ( up 58.0% year over year). The growth in sales was driven primarily by strong MacBook Air and MacBook Pro sales, as well as continued strong demand for iMac.

iPhones: iPhone unit sales were 37.0 million during the quarter, representing a year-over-year growth of 128.0%. Revenues from iPhone handset sales, accessory sales and carrier payments skyrocketed 133.0% year over year to $24.4 billion in the quarter.

iPads: Total iPad units sold in the quarter were 15.4 million, up from 4.6 million sold in the prior-year quarter. Recognized revenues from iPad and accessories during the quarter shot up 99.0% year over year to $9.2 million.

iPods: Apple sold 15.4 million iPods during the quarter, representing a unit decline of 21.0% from the year-ago quarter. According to MPD data, Apple's share of MP3 players in the U.S. was over 70% in the month of December, and iPod emerged as the highest-selling MP3 player based on the latest data published by GFK. iTunes store generated revenues of $1.7 billion during the quarter.

Retail Stores: Retail revenues in the quarter came in a record $6.1 billion, up 59.0% from the year-ago quarter, primarily attributable to increased Macintosh, iPhone and iPad sales. The retail stores sold 1.1 million Macs in the quarter compared with 851,000 in the year-ago quarter. During the quarter, Apple opened 4 new retail stores, 3 of which were outside the United States. At quarter end, Apple operated 361 stores worldwide.

Apple’s app store continues to top the charts with more than 500,000 apps. Apple released iOS 5 and iCloud during the quarter. The new operating system includes attractive features such as the Notification Center, iMessage and Reminders.

iCloud services are accessible from the iPhone, iPad, iPod Touch and are based on the new iOS 5 and Macintosh running on Mac OS X Lion with a valid Apple ID. An Apple ID would enable users to store and retrieve applications in the cloud and more than 85 million customers are already availing this service to date.

Operating Performance

Gross margin expanded 470 basis points (bps) year over year to 44.7%, well above management’s forecast of 40.0%, driven by lower commodity and other product costs. Operating margin increased to 37.4% from 29.3% recorded in the year-ago quarter. Total operating expenses increased 36.1% year over year to $3.36 billion (down 190 bps to 7.3% as a percentage of revenue).

Net income stood at $13.1 billion in the quarter, reflecting an astounding growth of 117.6% from $6.0 billion in the year-ago quarter.

Balance Sheet

Apple’s balance sheet remains strong. Cash and investments were $97.6 billion at the end of the quarter compared with $81.6 billion in the previous quarter. The company generated $16.2 billion in free cash flow during the quarter versus $10.5 billion in the previous quarter.

Second Quarter Guidance

For the second quarter of fiscal 2012, Apple expects revenues of approximately $32.5 billion. Earnings are projected at approximately $8.50 per share. The Zacks Consensus Estimate was pegged at $8.98 per share at the time the company reported its fourth quarter results.

Apple expects gross margin to be 42.0%, reflecting stock-based compensation expense of approximately $60.0 million. Operating expenses are estimated to be $3.05 billion, including about $350.0 million in stock-based compensation, while other income and expenses are anticipated to be around $125.0 million. The tax rate is estimated to be about 25.25%.

Our Take

Apple has outperformed the broader market in recent times. Apple shares have surged 23.1% in the past 12 months compared to a 2.0% growth in S&P 500. We believe that Apple is currently undervalued, and expects further upside in share prices over the next 12 months.

We believe that Apple remains the biggest growth story based on its superior product pipeline, Apps, recently launched iCloud and iPhone 4S and the upcoming update of iPad and Apple TV. Apple is also well positioned to gain from a loyal customer base and international expansion going forward, in our view.

Apple is currently expanding its business in China, Brazil and Russia. During the first quarter, Apple released iPhone 4S in China, which received stupendous response. The company has also acquired approximately 40 patents in China. We are appreciative of Apple’s approach of acquiring patents, which will lead to incremental growth in China, as well as in other emerging economies in the Asia-Pacific region over the long term. Apple’s ability to spur the popularity of its products in developing nations, where pricing is often an important consideration, will go a long way in deciding the company’s future growth, in our view.

However, stiff competition from Samsung, HTC, Motorola Mobility Holdings Inc. (MMI) and Google Inc. (GOOG), saturation in its major markets and increasing legal complexities remain concerns. We also believe that Apple’s secretive approach makes it very difficult to assess the company and this lack of visibility induces us to remain on the sidelines.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Apple has a Zacks #2 Rank, which implies a Buy rating in the near term.

Zacks Investment Research



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