AAPL 4Q11 Earnings Cheat Sheet

AAPL Orchard Estimates (change from previous estimate in italics)

Revenue: $32.6 billion (up $600 million) (guidance: $25.0 billion/consensus: $29.0 billion)

GM: 40.5% (down 40 basis points) (guidance: 38.0%/consensus 39.6%).

EPS: $8.55 (up $0.10) (guidance: $5.50/consensus: $7.16).

Product Unit Sales Estimates 

Macs: 4.8 million (up 100,000)

iPad: 11.8 million (up 700,000)

iPod: 7.2 million (unchanged)

iPhone: 23.3 million (unchanged)

I remain confident in my initial quarterly estimates, published July 26, making only modest tweaks to a few variables. I raised my iPad sales estimate 700,000 units to reflect a higher production yield. I am maintaining my iPhone sales estimate (which I initially thought was too high) as the iPhone 4S is pushed out to 1Q12 and iPhone 4 supply draw-down did not occur to any major extent in 4Q.

Things to look for:

iPad Sales. Apple may provide an iPad sales update at next week’s iPhone event. Apple was successful in increasing iPad production in 3Q11 and many will look for continued gains in 4Q11. While my estimate calls for 11.8 million iPads, Street consensus may actually be slightly higher. I think iPad sales greater than 10 million will be deemed okay by the Street, while more than 13 million iPads will be considered strong.

iPhone Sales. With the iPhone 4S launch pushed out to 1Q12, I don’t think we will see too much of a drop-off in iPhone 4 demand, especially considering iPhone 4 was recently brought to new carriers and countries. Apple may still get a pass if iPhone sales are on the weak side as analysts will simply blame iPhone 4S ramifications such as pent-up demand. iPhone sales greater than 20 million will be deemed good, while more than 25 million will be considered strong. iPhone 4S launch weekend sales figures may also be shared on the call (although it is just as possible that the iPhone launch will occur after October 18 or Apple will choose to not disclose initial sales).

Guidance.  Similar to previous quarters, investors will look for Apple’s 1Q12 guidance for evidence of any economic impact or weaker iPad/iPhone production plans. Unfortunately, management’s conservative nature will make it very difficult to reach solid conclusions.  My initial 1Q12 EPS estimate is $10.00 (Street consensus is $8.83) on $39.7 billion of revenue.  I would consider EPS guidance around $7.00, with revenue in high $20s billion, as solid.

Two other scenarios may occur: 1) Apple may announce extra conservative EPS guidance due to economic concerns or 2) iPhone supply concerns related to the iPhone 4S launch. I think extra conservative EPS guidance would be something like $5.50, which compares to Apple’s reported $6.43 in 1Q11 (one could make the argument that Apple will put guidance at least above last year’s $6.43 EPS).

If Apple delivers a blow out 4Q11 quarter, chances are good Apple may run with extra conservative 1Q12 guidance as analysts won’t necessarily increase 1Q12 estimates, but would still maintain Apple target prices due to the 4Q11 beat. Accordingly, expectations wouldn’t be raised too high and Apple will be in a good position for another solid holiday quarter.

Thoughts on Facebook F8

1) Replacing the World Wide Web. Facebook is focused on replacing large swaths of the web.  We got to see Facebook’s plan for sharing media, and I suspect we will hear Facebook’s take on other web functions, such as commerce, search, and utility, in the future.

2) Facebook Hates Privacy. Privacy remains Facebook’s major roadblock as web-replacement initiatives don’t look as appealing if Facebook users flock to high privacy safeguards. Although society has grown more comfortable with sharing information on the web; users’ ability and willingness to share will only strengthen Facebook’s intentions. 

3) An Alternative. Facebook is presenting an alternative to Apple’s app model in terms of how users access and use third-party content.  By no means is Facebook’s app model guaranteed to succeed, but it is clear that Apple’s native app model will have some form of competition. Apple has made an effort to point out the billions of dollars in app revenue returned to developers and I think Apple will reinforce this point, arguing app innovation should continue to flock to the iOS platform because developers actually get paid. 

4) Changing Landscape.  We are in the beginning stages of a changing tech landscape where the hardware battle will be won by economies of scale and uniformity, while the software battle is won by seamless integration between the social network and third-party content. Apple is in a prime position to reap competitive advantages from its manufacturing and supply chain economics of scale, while iPhone and iPad popularity may soon result in 100s of millions of iDevices in the wild.  Meanwhile, I believe Facebook has already won the social network race and will now work on increasing and improving third-party content utilization. Apple and Facebook are in prime position to control the tech landscape. 

Anchoring Bias Impacting Wall Street's View on Apple

Predicting tech trends beyond 6-12 months is somewhat of a futile endeavor, but two groups of analysts attempt the feat: paid and non-paid.  Paid analysts largely encompass sell-side analysts - think along the lines of Goldman Sachs and Piper Jaffray. Non-paid analysts include everyone else and seem to have acquired the “independent” nomenclature.  There remains another group - buy-side (think hedge funds and mutual funds) - who don’t actually publish Apple forecasts, instead utilizing paid (and independent) analysts forecasts. 

Modeling Apple’s business (and earnings) involves two parts:  

1) Knowing how to model a company’s financials. This is the easy part.  Setting up an excel sheet to model revenues, expenses, and earnings going forward.  Financial modeling is essentially Finance 101 (ironically many students have no clue what they are doing when they take intro Finance classes since the field is so disorganized academically in primary and high school).

2) Knowing how to model a company’s performance. This is the hard part. This is the part of modeling that is more art than science.  How many iPads will Apple sell next year?  How about iPhones?  Experience, intelligence, and a clear mind separate the amateurs from the professionals. 

I’ve discovered that looking at someone’s forward Apple projections reveals a lot about what they think of Apple and this is where things get interesting. Sell-side consensus for Apple earnings per share currently stands at $32.35 for fiscal year 2012 and $36.94 for fiscal year 2013.  From a stock valuation standpoint, these numbers are important, but converting these numbers into growth, Wall Street believes Apple will grow 18% in 2012 and 14% in 2013.

In order to put these numbers in context, I compare Apple’s projected earnings growth to other technology companies:

             2012     2013

GOOG:    19%       17%

IBM:        11%       11%

MSFT:      6%          9%

HPQ:      -1%          2%

RIMM:   -20%         2%

DELL:      26%       -2%

Average:  7%        7%

AAPL:     18%       14%

(consensus data from FactSet and current as of 9/10/11) 

Now we are getting a better picture of how Wall Street views Apple. Tim Cook and company are expected to outperform the overall technology sector, growing earnings 14% in 2013, versus a peer average of 7%.  However, Apple’s 14% projected growth in 2013 pails in comparison to current 70% growth.  What is going on here?

Instead of sell-side analysts “not getting it” - as some independent Apple analysts say, I think anchoring bias is the main culprit. 

I thought Wikipedia did a good job at trying to define anchoring in a few sentences:

Anchoring and adjustment is a psychological heuristic that influences the way people intuitively assess probabilities. According to this heuristic, people start with an implicitly suggested reference point (the “anchor”) and make adjustments to it to reach their estimate. A person begins with a first approximation (anchor) and then makes incremental adjustments based on additional information.

Sell-side analysts are comparing Apple to its peers too much. Although analysts still believe Apple will outperform, many are modeling Apple with a 5-10% technology industry growth rate in mind. Apple’s growth is then pegged above this range, albeit by only a small margin.  Apple is being anchored to its peers and corresponding lower growth rates.

Sell-side analysts may think Apple will sell a ton of iPhone and iPads, but end up with much lower Apple growth rates because Apple’s peers are performing so poorly. To make matters worse, much of this comparing, and anchoring, is occurring on a subconscious level, making it that much harder to acknowledge and correct. 

Meanwhile, independent Apple analysts aren’t subjected to anchoring bias since they are only modeling Apple.  In a way, they are able to put Apple in a valuation bubble.  If independent analysts began to model Apple peers on a regular basis, I would suspect anchoring would become a bigger issue among the group.

As an independent Apple analyst, how fast do I think Apple will grow earnings?

2012:   40%+

2013:   35%+

My 2012 earnings growth estimate is twice the pace of Wall Street’s 18% growth estimate.  

RIMM’s troubles, HPQ’s reorganization, MSFT’s status quo, and GOOG’s continuing mystery are causing Wall Street to view Apple with a more conservative eye. What is the solution? Unfortunately, I don’t expect Wall Street’s anchoring bias to end anytime soon. Apple will continue reporting large quarterly earnings beats, while Wall Street continues to gush over Apple’s growth.