Monday, April 14, 2014

Fiscal 2Q 2014 Final Estimates

As of Friday's close of $519.61 AAPL is trading at 10.5 times my next-twelve-months EPS estimate (7.5x ex-cash). The biggest impact to my estimates for the quarter and rest of CY14 is due to China Mobile ramp much slower than I originally modeled in January. Taking guidance quite seriously now, thus estimating a significant drawdown in iPhone/iPad channel inventory (about 4.5m units) resulting in a $2.5b revenue impact, which prevents grossly exceeding the top range of guidance for last quarter. Expect management to highlight sell-through numbers.

Detailed estimates:

3mo ending Mar-2014   Rev($M)   EPS($)   GM(%)
-------------------   -------   ------   -----
Analysts consensus     43,570    10.15
Apple guide low        42,000     9.46   37.0
Apple guide high       44,000    10.53   38.0
Deagol estimates       44,053    10.60   38.1 (884m shares)

3mo ending Jun-2014   Rev($M)   EPS($)   GM(%)
-------------------   -------   ------   -----
Analysts consensus     38,380     8.51
Apple guide low (e)    38,000     8.46   37.0
Apple guide high(e)    41,000     9.85   38.0
Deagol estimates       40,881     9.79   37.9 (866m shares)

12m ending Sep-2014   Rev($M)   EPS($)
-------------------   -------   ------
Analysts consensus    180,330    42.60
Deagol estimates      186,522    45.96

Valuation (12mo ending on)   EPS($)  Y/Y  10x  Cash* Div   Tot
--------------------------   ------  ---  ---  ----  ---  ----
Trailing        (Mar-2014)    40.83  -3%  408   152   12   573
Fair value      (Mar-2015)    49.29  21%  493   177   13   683
1yr target      (Mar-2016)    54.70  11%  547   213   16   776

* Cash balance net of long-term debt

F2Q14 Revenue breakdown (millions, except ASPs):
Mac        5,446 ( 4.1 × $1,328)
iPod         455 ( 2.8 × $162)
iPhone    24,426 (39.0 × $626)
iPad       7,974 (18.0 × $443)
iT/S/S     4,440
Accssr     1,313

Income statement (millions, except EPS):
Revenue   44,053
COGS      27,248
GM        16,806
OpEx       4,357
OpInc     12,449
OI&E         215
Pre-tax   12,664
Tax        3,293
NetInc     9,371
Shares       884
EPS       $10.60

GM%        38.1%
OpInc%     28.3%
Tax%       26.0%
NetInc%    21.3%


JavaJack said...

Thanks for this. Can you explain what the last sentence means? "Expect management to highlight sell-through numbers"


Daniel Tello said...

Sell-through means sold to the final customer, and so it's a more realistic measure of demand. Apple's direct sales (Apple Store, Online Store, and education) are all sell-through, but a significant portion (particularly with iPhone) is sold through third-party channels. In this case Apple reports just the sales into this indirect channel, aka sell-in. It needs to keep some inventory in the channel in order to support sales, but not too much. Apple's usual channel inventory targets are between 4 to 6 weeks worth of demand through that channel.

When sell-in is higher than sell-through, it's building up channel inventory, aka channel fill. They report the revenue even though the units are still in store shelves. If instead sell-through is higher, as I'm modeling for this last quarter, it means a reduction in the channel inventory, aka drawdown (as mentioned in the post).

Apple shares their channel inventory levels only on the financial results conference calls with analysts. The changes in channel inventory (positive or negative), when subtracted from the reported sales (sell-in) gives you the sell-through or underlying demand. Of course, subtracting a negative number results in higher underlying demand than suggested by the reported sales, and they will make sure to highlight it for investors if this is the case.

Here's Tim Cook from the last conference call:

"I think it’s important to listen to what Peter said about the guidance, and about the compares year over year, and the point that he made that the underlying sell through, that we’re very confident of growth year over year. And that is the way we look at it. Some people just look at the numbers on a piece of paper, but the way I’d look at the business is our business from a sell through point of view less iPod, because I think all of us have known for some time that iPod is a declining business.

And when you do that, the numbers from last quarter, and the deferral, which we’ve just increased, as Peter went through, when you look at that, and look at the numbers from last quarter, it comes up to a double digit growth. And we’re proud of that. I think that’s a pretty good result. We’ll see how we do in the March quarter, but I do think it’s important in the March quarter to take into consideration sell through versus just a view of sell in."

JavaJack said...

Thanks for the very comprehensive response, Daniel.

jz said...

can you give some colors behind your iPad number? thanks.

Daniel Tello said...


As Tim insists, you really need to track the y/y growth in sell-through and not sell-in (which is what they report). See Tim's quote in my previous comment.

So, here's iPad unit sell-through and its growth rate over the last couple of years:

Period, Sell-thru(m), Growth(%)
Q1FY12, 15.6, +130
Q2FY12, 12.1, +138
Q3FY12, 15.8, +75
Q4FY12, 13.8, +43
Q1FY13, 22.9, +46
Q2FY13, 18.1, +49
Q3FY13, 15.3, -3 (no spring iPad update)
Q4FY13, 14.1, +2
Q1FY14, 23.9, +5

So looking at that oh-so-gradual growth rate recovery, I'm optimistically projecting +8% in Q2 and about +10% in Q3. That means 19.5m and 16.85m units respectively. But that's sell-through and not what Apple gets to recognize as sales. To get to sell-in we need to work a bit harder.

The problem is, Apple had 6.2m iPads in the channel as of the end of December, and this is a bit excessive to support that level of sell-through in Q3. How do I know this? Again, from the conference call disclosures of channel inventory and comments about being below or within the target range. Just remember that the channel inventory is there to support only indirect sales, as I mentioned in my other comment.

Using that somewhat rough info of how they missed or hit the target range, and with attention to detail, some common sense and quite a bit of perseverance, you can derive a recent (last year or two) ratio of roughly 70% indirect unit sell-through out of the total iPad unit sell-through. This helps quite a bit since now we can derive, given a sell-through estimate, the unit inventory level Apple needs to be at the beginning of that quarter (since it's on a look-forward basis) if it wants to hit its target range.

So, all we need to do is take 70% of the sell-through number above for Q3, divide by 13 (weeks in a quarter) and multiply by 5 (weeks of channel inventory) to hit the midpoint of the range. Of course Apple could end up at the higher limit of 6 weeks if it doesn't care to reduce inventory too much (or if demand turns out lower than that estimate), but I imagine Tim wants to play it safe and get this resolved right away. So, this simple calculation gives the channel inventory level required at the end of Q2 to support the desired sell-through for Q3.

That is, 70%*16.85*5/13=4.54m units in channel inventory by end of March. Or if Tim decides to play it a bit loose, 70%*16.85*6/13=5.44m units. So this means the reduction fom 6.2m must be at least 760 thousand to hit the top limit of 6 weeks, or preferably they'll reduce it by 1.66m to hit 5 weeks. This reduction would impact the March sales estimate, since Apple would only get to recognize the difference: 19.5m sell-through minus 1.66m drawdown is 17.86m (or 18.77m for the riskier option). I rounded it to 18m iPads to stay closer to the safer choice.

Any higher estimate needs to justify an ambitious sell-through growth rate, which hasn't been there in the last 3 quarters. Another possibility is an expansion of the iPad third-party channel distribution where the ratio could now be, say, 80% (iPhone is around 90%). In this case only a one million unit reduction from the 6.2m level would be required to hit the midpoint of 5 weeks of inventory in March to support the slightly higher indirect sales in Q3, and thus would imply Q2 sell-in of 18.5m.

Hope that helps. Happy Red Moon!

jz said...

Thanks for the details.
China Mobile started selling its version of iPad on April 1, did CHL get the inventory in March? probably not enough to matter.

Daniel Tello said...

jz, CHL selling iPads in Q3 does mitigate the need for drawdown in Q2 even if their dedicated inventory was low in March. Only question is what share of all iPads would sell through CHL in Q3?

Jeff said...


Your June guidance is higher than anything I would have expected. Is it due to Deferred Revenue swinging favorably into the "plus column?" That is, the amortization of prior deferred revenue is significantly stronger than the amounts deferred on devices sold in the June quarter?

Apple deferred approx. $900M in the December quarter alone, so I'm curious if your estimates of June guidance is part of the explanation for $40.8B June Rev guidance. Thanks!

Anonymous said...

Can you add some detail on why you think Apple will reach $40.8B in revenue for June?

Daniel Tello said...

Jeff and Anon (perhaps the same person), I see decent growth in the underlying sell-through (Tim said double digits so I'm not alone I guess) combined with higher ASPs from last year. We'll see how they guide tomorrow.

JavaJack said...

Well??? Curious about your thoughts following today's report.

Daniel Tello said...

Jack, I'm very happy with the iPhone surprise. I was ahead of the consensus there. Nearly 44m units is quite amazing for a non-Holiday non-launch quarter. Let's hope this strength doesn't fade for the rest of the fiscal year.

I'm not too worried about iPad as it seems the life-cycle of the product is quite longer, maybe 4 years or so (lots of iPad 2s still in use and lots of new-to-iPad customers). I trust they'll come up with a compelling update later this year (and perhaps tweak the pricing of the mini retina until then). I was on the lower end of the range of estimates on iPad, so at least I got that directionally right as well.

As for the rest, I pretty much got most of it right. The GM and EPS were higher due to the better mix (higher iPhone, lower iPad), but my underlying assumptions are sound.

I even got a mention from PED, see here:

The cash return program expansion is just as I expected, and the unexpected 7:1 split is welcome. All good moves. Tim sounded quite confident on the call, and the new CFO sounds great as well. The stock move AH and this morning reflect this, and I see a continuation of that.

Guidance is a bit below my estimates, but it now seems they're able to beat their guidance by wider margins than we got used to over the last year or so. I'll revise everything as always and post what's what in a couple of months. Hopefully WWDC provides some clues that I can apply to my numbers.

Cheers and good luck!

JavaJack said...

Congratulations on your numbers and also the mention you received from PED. I was busy with clients so wasn't able to listen to the conference call. Came out to discover a surprise with the 7:1 split. Trying to imagine what this split will actually do. Provide an opportunity for smaller investors. What about current holders of the stock? Anyway, look forward to your next post.

Anonymous said...

Another way of estimating $AAPL EPS is to take the EPS of last year ($ 1.07) and to multiply it by :

1. The effect of the buy back (6.02 B shares versus 6.47 B shares last year) i.e. an increase by 7.48%;

2. The increase of estimated turnover year over year (estimated $ 38 B versus $ 35.323 B) i.e. an increase by 7.57 %;

3. The increase of GM year over year (estimated 38% versus 36.9% last year)i.e. an increase by 3%.

The overall increase YoY is 19% (1.0748 * 1.0757 * 1.03) which gives an EPS, based on the EPS of last year, of $1.27.

If I use ayour estimated revenue ($38.75 B i.e. an increase of 9.7% YoY) and your estimated GM (38.7% i.e. n increase of 4.87% YoY), estimated EPS is of $1.32 [1.07*1.0748*1.097*1.0487].

The complex calculation consisting in first guessing the number of Iphones sold, etc. and then trying to guess the estimated revenue by applying an estimated ASP is too hazardous. It is better to use last year figures and to apply the high end of the estimates given by Apple.

I do not know why these figures are so important for Apple since the market does not seem to care about them. In Q1 2013 about 18 months ago, $AAPL earnings were impressive but it tanks by more than 10% the very next day.

It means that even if $AAPL results are impressive this afternoon, $AAPL might significantly decrease tomorrow. If $AAPL results are below expectations, it might even increase by another 3%.

Market is currently and on short term a voting machine based on unknown and not predictable impressions of Mr. Market. On medium term though, these cumulative earnings are important. As long as quarterly earnings grows by more than 10% YoY, $AAPL stock on medium / long term will be fine.

Daniel Tello said...

Anon, congrats on getting a number much closer to actuals through your simpler method. I still think the more "hazardous" yet more easily "modelable" way through units and ASPs (how would you estimate further down the road without an Apple-provided revenue range?) is useful.

"I do not know why these figures are so important for Apple since the market does not seem to care about them. In Q1 2013 about 18 months ago, $AAPL earnings were impressive but it tanks by more than 10% the very next day."

The market, of course, also keeps an eye on guidance. That explains those moves (seems Apple met on that this time, thus the stock is flat so far).