Apple will likely report strong 1Q15 earnings on Tuesday. The iPhone 6 and 6 Plus have resonated with consumers across the world and will help propel iPhone unit shipments to a record quarterly high. Partially offsetting some of the iPhone strength is continued weak iPad shipments as the product finds a more steady sales run-rate. The strong dollar is serving as a headwind and will likely impact 2Q15 guidance, although Apple's foreign exchange hedging program will mitigate some of the negative impact. The combination of continued share repurchases, an updated product lineup, and additional revenue from Apple Watch, will likely result in Apple reporting 20%-30% EPS growth in 2015.
Exhibit 1: Above Avalon's AAPL 1Q15 and 2Q15 Estimates
Things to Consider
- Revenue and Margin Guidance. I will be looking for clues as to how the iPhone 6 and 6 Plus are expected to sell January through March, and if the Apple Watch will launch in March. Keep in mind, the strong dollar may impact revenue and margin guidance a bit, so the conference call may be required to get the full picture. Any negative impact from foreign exchange will likely be backed out and considered non-operating.
- Management Commentary on iPhone. Any insights as to upgrade versus new user trends for iPhone, as well as China sales will help in terms of modeling.
- iPhone ASP. With additional moving parts in the iPhone line (storage capacity mix shift and two current iPhone models), the iPhone ASP is likely to see an increase ($660 estimate, up from $637 last year). Any significant change from $660 would likely change my forward revenue estimates.
- iPad Sales and ASP. Unit sales are expected to be down year-over-year for iPad, but is there any evidence of stabilization in sales trends? Would a lower than expected ASP suggest the iPad mini is more popular than expected?
- Share Buyback. Was there any change in share buyback momentum during the quarter ($5 billion/quarter estimate)?
Revenue and EPS
I am calling for a slight revenue beat to both consensus and guidance on strong iPhone 6 and 6 Plus sales. Working through an above consensus revenue expectation and 38.5% margin estimate (in-line with guidance), I am expecting Apple to report EPS of $2.62, slightly higher than consensus of $2.59.
Exhibit 2: Apple Revenue and EPS Expectations
My current 2Q15 estimate includes $56B of revenue and 39.4% gross margin. If management guides to $50B-$53B of revenue, I would't expect much change to my forward estimates. Anything under $50B of revenue and I would likely need to lower my iPhone estimates. If the Apple Watch is launched at the end of March, then guidance will likely reflect the corresponding $1-$2 billion of additional revenue.
Product Unit Sales
Even though I provide unit sales estimates for modeling purposes, it is more appropriate to consider ranges when looking at quarterly product unit sales. Exhibit 3 details my iPhone, iPad, and Mac unit sales expectation meters. My estimate is highlighted in white, while the grey area represents unit sales that would be close enough to my estimate to not elicit much of a surprise. Anything in green would be much stronger than expected, while red would indicate weaker than expected.
Exhibit 3: Apple Product Unit Sales Expectation Meters (1Q15)
One way to think of Exhibit 3 is that my thoughts about iPhone, iPad, Mac would need to be adjusted if actual product sales fell in the green or red zones. If the results fall in the grey zone, than my current expectations are mostly intact.
Nearly every data point and customer survey over the past three months have supported the view that iPhone 6 and 6 Plus are selling quite well with lack of supply being the biggest risk to 1Q15 sales estimates. My 68.9M iPhone unit estimate suggests 35% year-over-year growth. There are still supply and demand imbalances in certain countries, which would suggest the number Apple reports on Tuesday will simply represent the amount of iPhones that were able to be shipped. The implication of this is that any iPhone shipment number (no matter how low) will likely be given a pass as investors focus on the next quarter. There has been no significant change to my iPhone estimate since November. I take the 51M iPhones sold in 1Q14 and apply 20% sell-through growth (matching Apple's stated growth trends in 4Q14). I then add 5M unit to reflect China Mobile and 2M for channel inventory build.
I am expecting weak iPad sales of 19.5M, representing a 25% year-over-year decline in unit shipments as the product continues to find its place within the Apple ecosystem. Earlier this week, I discussed how Apple is likely repositioning the iPad in relation to the iPhone and Mac, which ultimately suggest we are in the process of finding iPad's normalized sales run-rate. My iPad estimate reflects a combination of analyzing Fiksu iPad model share trends (U.S. and Europe focus) from September to December, in addition to a 1.5M channel build estimate.
All indications point to another solid quarter for Mac with IDC and Gartner suggesting 5-6.5 million units as a likely sales estimate. Mac sales may be continuing to bounce back as iPad sales cool, suggesting MacBook Air models remain a popular purchase.
Given Apple's revised reporting segments, my expectations for Services (iTunes/software/services and Apple Pay) is $4.8 billion, while I am modeling $2.3 billion for Other Products (iPod, Beats headphones and speakers, Apple TV, and peripherals and accessories for iPhone, iPad, Mac, and iPod).
Apple is currently trading at a 17x trailing twelve month (TTM) P/E. Exhibit 4 shows that Apple has traded within a trailing P/E range of 12-18x (using year-end data) since the U.S. financial crisis. While Apple's P/E remains at a discount to the overall S&P 500, the gap has been closing. Using my 2015 and 2016 estimates, Apple's forward P/E currently stands at 13.4x for 2015 and 10.9x for 2016, which suggest there is some market pessimism that Apple will be able to meet my estimates (likely due to questions surrounding iPhone 6s sales in late 2015 and 2016 and Apple Watch sales).
Exhibit 4: Historical P/E (TTM)
Exhibit 5 includes different valuation scenarios assuming various 2015 EPS estimates. My $8.50 estimate column is highlighted in yellow.
Exhibit 5: AAPL Valuation Matrix
In terms of valuation, the iPhone continues to be the primary focus for Apple investors, while the Apple Watch remains a wildcard as expectations target 15-20M unit sales in the first 12 months.
This report was produced by Neil Cybart on January 23, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard. Click here for more information and to subscribe.