AAPL 1Q13 Preview; Near-Term Volatility Continuing

Revenue: $53.1 billion (AAPL guidance: $52.0 billion/Consensus: $54.5 billion) 

• I expect Apple’s revenue to increase 23% year-over-year after adjusting for the 14 weeks in 1Q12.

GM: 37.9% (AAPL guidance: 36.0%/Consensus: 38.4%)

• Apple’s margin is expected to decline sequentially from 4Q12 primarily due to the wide range of updated products. Margin remains a key near-term unknown for AAPL. Management’s 36% margin guidance is 870 basis points less than the 44.7% margin reported in 1Q12, making EPS growth difficult to achieve. I still include expanding margins throughout 2013.  Further weakness, or a shallower rebound, may result in an additional EPS growth headwind.

EPS: $12.75 (AAPL guidance: $11.75/Consensus: $13.33) 

• I expect Apple to report a 1% yoy EPS decline, when adjusting for 1Q12. While my $12.75 estimate is less than the Street’s $13.33 average, I attribute much of the variance to my lower gross margin expectation.

Product Unit Sales and Commentary

Macs: 5.2 million (flat yoy growth)

• Mac growth continues to slow as tablets and smartphones satisfy many consumers’ computing needs. I expect 10% growth in portables driven by holiday shopping to be mostly offset by nearly a 30% decline in desktop sales due to the new iMac release schedule.

iPad: 22.4 million (56% yoy growth - when adjusted for 1Q12)

• I expect Apple to report record iPad sales for 1Q13. My iPad estimate assumes approximately 8-10 million iPad minis and 12-13 million iPad 2 and fourth generation units. The iPad mini went on sale November 2 with an aggressive rollout, despite significant pent-up demand and limited supply. Apple was able to sell three million iPads in the three days following the iPad mini and fourth generation iPad launch. My estimate assumes approximately 25-35% cannibalization of the larger iPad models (1 out of 3 consumers willing to buy a larger iPad purchased an iPad mini instead). Going forward, I expect iPad mini sales to approach, if not exceed, those of the larger iPad models. 

iPod: 12.0 million (16% yoy decline)

iPhone: 47.8 million (39% yoy growth)

• Apple made significant progress in reaching supply/demand balance for iPhone 5 in the U.S. and other launch countries. My quarterly estimate is largely based on AT&T’s recent comments on October and November smartphone sales (and additional extrapolation). Historical averages for AT&T’s share of global iPhones (and assuming a slighter higher mix of international sales) would imply 40-50 million iPhone sales, which I would consider the high probability estimate range.  I then assume channel fill of at least 1 million units, which positions my estimate in the narrower 46-48 million estimate range. 

Apple has missed Wall Street consensus EPS for the past two quarters, and unless estimates come down in the following weeks, a third miss isn’t out of the question. While it is hard to point to any one factor as driving a fundamental change in Apple’s operating performance, Apple’s prior two quarters have contained a few concerning metrics, including contracting margins and declining iPad and iPhone growth.  Did the weak global economy finally catch up to Apple? Were product release cycles continuing to wreck havoc with consumer demand? 

The bear argument would label Apple’s two-year stretch from 2010-2011 as an outlier, when two new products (iPhone and iPad) produced a perfect storm for EPS explosion.  Going forward, bears would argue margins will decline further, effectively limiting EPS growth. Future products would then lack the size to move the EPS needle. 

The bull argument would focus on iPhone and iPad as product leaders in its respective industries, while a temporary margin drop is indicative of product updates and not a fundamental change in the operating landscape. Apple’s future product plans would also occupy a spot in the conversation. 

Will 1Q13 represent an AAPL inflection point? I don’t think one quarter is capable of shedding enough light to figure out where Apple stands in its long, storied history. With iPhone now entering its 6th year (iPod recently celebrated its 11th birthday), the days of 100% revenue growth may be over for the product line, but should that statement even be considered controversial? There is also evidence suggesting Apple may be looking to smooth out demand cycles by updating products more frequently, a move that may bring long-term benefits, but at short-term costs.    

While much of the recent AAPL discussion has been focused on slowing growth and falling margins, it is easy to overlook fundamentals that would be considered very strong for any Apple competitor:

• A smartphone pulling in $80 billion of revenue annually and growing at least 30%.
• A tablet pulling in $30 billion of revenue annually and growing at least 45%.

A few AAPL loyalists have recently declared another “bad” Apple quarter (where bad is judged merely by EPS) will signal a new Apple, an Apple not deserving of their attention and instead lumped in with the rest of the tech crowd.  I disagree. One quarter, especially in the midst of an obvious change in business performance (product updates and management reshuffling), is not enough to conclude the long-term Apple story has changed. If an investor wanted to run away from Apple for near-term volatility, that decision could have been made a few months ago. Continued margin volatility may produce a scenario where EPS growth can accelerate throughout the year and 2014, even with slowing product sales growth. 

AAPL’s next 3-5 years will depend on management’s ability to introduce new product categories into an ecosystem that values a set of beliefs, including two that I tried to put into words following my first days with an iPad:

That technology is too powerful of a force to enjoy without acquired perception and natural intelligence.

That product design has the power to momentarily satisfy the never-ending search for order and reason.