For the first eight months of 2013 it was all talk about the stock (since it was in the penalty box), Apple losing market share in smartphones and tablets and speculation about a low priced iPhone. It finally turned to products in September with the iPhone 5c and 5s and got its mojo back. Below is a recap of the year and thoughts on 2014. (Note my family and I own Apple shares).
January: Start the year off with a whimper
Apple announced its December quarter results with revenue of $54.5 billon, up18% year over year, (and up 25% when adjusted for the previous years 14 week quarter) an all-time high. Gross margins were close to bottoming and while reported EPS declined year over year ($13.81 vs. $13.87 a year ago) this was again due to being compared to a fourteen week quarter (would have been up about 7% year over year). The 47.8 million iPhones increased 29% year over year and 26% when adjusted for channel inventory. The 22.9 million iPads increased 48% year over year and 46% when adjusted for channel inventory. While very good results it didn’t do anything for the stock.
This was the first quarter where Apple changed its guidance to ranges for revenue and gross margins and did not provide EPS (but could be determined from the details management provided). With the continued decline in gross margin and uncertainty about how low it could go, guidance significantly below expectations and concerns about increased competition the stock would fall from $532 at the beginning of the year to $443 at the end of March, down 17%.
Tim Cook, Apple’s CEO, also said on the earnings conference call “I would suggest it’s good to question the accuracy of any kind of rumor about build plans …. there is an inordinate long list of things that would make any single data point not a great proxy for what’s going on.”
The App Store tops 40 billion downloads with over half in the past twelve months in January with iTunes passing 25 billion songs in February.
February: First public activist investor tries to shake down Apple
David Einhorn sued Apple over the bundling of three proposals in its proxy as he tried to get the company to increase its stock buyback plan by issuing dividend paying perpetual preferred stock. He was successful in getting the proposal changed and helped to lead to the company increasing its buyback program in April.
April: The first year over EPS decline since at least 2003 but gives a hint about the future
The week before Apple announced its March quarter results the stock hit its lowest closing price of the year at $391, down 44% from its $702 closing high and down 27% from the beginning of the year.
March quarter results show revenue growth of 11% year over year with $43.6 billion in revenue but EPS of $10.09 was down 18% year over year. Gross margin came in at 37.5%, down from 38.6% in the December quarter, but there was an additional warranty accrual charge that hurt gross margin by almost 100 basis points so it was almost flat quarter over quarter. The iPhone’s 37.4 million were up 7% year over year and up 12% when adjusted for channel inventory. The iPad’s 19.5 million were up 65% year over year and 49% when adjusted for channel inventory.
The company announced that it was increasing its dividend from $2.65 to $3.05, an increase of 15%, along with increasing its buyback program from $10 billion to $60 billion. Over eleven quarters Apple plans to return $100 billion of the then $145 billion in cash and investments.
Tim Cook said on the conference call “we plan to continue to augment with new services, our plans for expanded distribution and the potential of exciting new product categories”. He added “our teams are hard at work on some amazing new hardware, software and services that we can’t wait to introduce this fall and throughout 2014.
May: The App Store hits another milestone
The App Store passes 50 billion downloads, an additional 10 billion since January, with over $10 billion paid to developers.
June: WWDC not enough to stop the stock from retesting its low for the year
Apple holds its Worldwide Developers Conference (WWDC) and announces iOS 7 that will have a completely redesigned user interface (I wish I had the option of using the previous interfaces such as the Notes), iTunes Radio and OS X Mavericks. To a degree investors are disappointed as an iWatch or breakthrough TV platform are not announced.
The stock retests its low of the year ($391 on April 19) by touching $394 on June 27.
July: Better than expected iPhone sales not enough to offset flat revenue
June quarter revenue of $35.3 billion was only up 1% year over year and gross margin fell 60 basis points from the March quarter to 36.9%. Warranty expenses were lower by 150 basis points or 1.5% from the March to June quarters so the drop was even larger with a more detailed look. EPS of $7.47 dropped 20% year over year as operating expenses hit 10.8% of revenue, the highest since the June 2010 quarter. The 31.2 million iPhones (up 20% year over year and 21% when adjusted for channel inventory) were higher than the 25 to 28 million expected with the 14.6 million iPads (down 14% year over year and 3% when adjusted for channel inventory) lower than the 16 to 19 million expected.
August: Carl Icahn starts to make some noise
Carl Icahn announces via Twitter on August 13 that he has taken a large position in Apple’s shares and believes the company is extremely undervalued. The stock is up $22 or 5% to $490.
September: Starts the new product announcements
The month starts off with the iPhone 5c and 5s being announced. While a number of people are disappointed that the iPhone 5c was not priced lower and that the screen size did not increase there were a number of advancements including the 64 bit A7 processor, M7 motion coprocessor and Touch ID.
NTT DoCoMo was also announced that it would start carrying iPhones and two weeks later the company announced that it had sold 9 million iPhones over the first weekend.
The iMac was updated with fourth generation Intel quad-core processors, new graphics and next generation Wi-Fi towards the end of the month.
October: New head of Retail announced along with “Its going to be an iPad Christmas”
After taking almost a year Apple announces a new head of retail, Angela Ahrendts the CEO of Burberry. Expectations are running high with her use of technology to increase Burberry sales and after John Browett lasted only six months and seemed to have implemented a number of initiatives that did not go over well.
The iPad Air and the iPad mini with Retina display solidify Apple’s dominance of the tablet market. The Air weights just one pound and feels feather light when held and became available on November 1. While it has the A7 processor it doesn’t have Touch ID. The major upgrade to the mini was incorporating a Retina display, its price increased from $329 to $399 and became available on November 12. The duo leads Tim Cook to say on the earnings conference call that “Its going to be an iPad Christmas” and multiple indicators back him up.
The company also announced a very powerful Mac Pro with a complete redesign, updated MaBook Pros and that iWork and iLife are now free with the purchase of every new Mac or iOS device.
September quarter revenue of $37.5 billion increased 4% year over year and gross margins increased 10 basis points or 0.1% to 37.0%. Additionally warranty accruals at 3.7% of revenue were materially higher than the previous quarter’s 2.1%. If they had been flat then gross margins would have been 38.6%, materially above the previous quarters 36.9%. EPS of $8.26, which was the second quarter in a row that I correctly projected EPS, was down 5% year over year.
The 33.8 million iPhones were higher by 26% year over year but when adjusted for channel fill were up 17%. The 14.1 million iPads were flat year over year and up 2% when adjusted for channel inventory.
December: China Mobile partnership finally gets announced
The long awaited China Mobile partnership is announced after a slew of smoke signs. With its 763 million users, 181 million on 3G technology, the estimates range from a low of 5 million to over 20 million in the first year.
The stock closes at $561, up 5.5% for the year.
2014: There will be extensions. The key question is will there be a new category or service?
One of the key questions to be answered this year is can Apple bring a revolutionary new product or service to market or will it be a year of extensions to its existing product lines.
There will most certainly be a larger screen iPhone. Apple is late to the game and has lost a significant number of unit sales, profits and allowed competition, at least Samsung, to gain significant traction. It may very well come out with a larger screen iPad which is being dubbed the iPad Pro. Both of these are worthwhile extensions especially a larger screen iPhone.
I do believe the A7 64 bit architecture is critical to delivering amazing solutions down the road but it and Touch ID are just the beginning stages. As developers get the hands these technologies they will be able to create applications and solutions that were not available before. This has been the same cycle since Xerox’s Alto became available in 1973 (only to Xerox employees) with a maximum 512 kB (yes kilo bytes) of memory. However these solutions could take a few years until they are fully deployed.
The initial MP3 player was released in 1995 and the iPod became available six years later in 2001. Per Wikipedia the first PDA was released in 1984 by Psion, Apple’s Newton was released in 1993 and Palm starting shipping units in 1996. It wasn’t until 2010 with the iPad that tablets came into their own. I believe these are relevant data in that it shows that Apple waits until the technology is well along its way and sees that a market is developing before it releases a product.
The two categories with the greatest amount of speculation are wearables or an iWatch and TV.
The iWatch may see the light of day this year
The first Fitbit was announced in 2008 and Nike’s FuelBand became available two years ago in January 2012. While these and others haven’t been out as long as other products cited above I do believe tech cycles are shortening and that this is one area Apple has been focused. As Tim Cook said at the AllThingsD conference last year “I think the wrist is interesting. The wrist is a natural”.
Some of the key technical hurdles, such as battery life, have had good progress as seen with the multi-day charge for Qualcomm’s Toq. Some of the key challenges are design (which Apple is very good at) and applications (which Apple has a very large developers network to tap into). One key question is will enough people spend $299 or more to make this a multi-billion market?
I don’t see an Apple TV on the near-term horizon
I believe there are multiple challenges, and they largely aren’t technical, with Apple bringing a television solution to market. First the television set business is a lousy business. It has low margins, long replacement cycles and large competitors. I don’t think the company could bring to market a hardware platform that wouldn’t be readily available to others or be able to charge enough to deliver the margins that Apple is used to.
Additionally, the television and movie content providers are probably more challenging to negotiate with than the record industry. The record industry was in decline when Apple brought out the iPad and iTunes vs. video content creators have multiple distribution channels. While an al la carte service could have high demand getting the content providers on board may not be in the cards as they don’t seem to have much interest.
The company may be able to bring an interesting user interface for viewers (I happen to love our TiVo and it would be almost impossible to replace it in our household unless something meaningfully different came along) or if it could solve the cabling rats nest in the back of all the devices that are used in today’s systems I would be willing to entertain an Apple solution.
New services could bring high margin revenue
The App Store generated $8 billion in revenue for app developers and about $3.5 billion in revenue for Apple in 2013. This compares to about $3.5 billion in revenue to developers and $1.5 billion to Apple in 2012. Overall App Store revenue more than doubled from 2012 to 2013. While App Store growth will ratchet down it is generating very good growth and at what should be good margins.
iBeacons is an interesting technology/solution and seems to be gaining traction, especially among retailers. If Apple can get a percentage of revenue generated by this solution it could provide an interesting revenue stream for the company.
The other service which could tap into a very large market is getting a slice of payments. Since Apple has credit card information on hundreds of millions of customers if Apple can get 20 to 30 basis points of a transaction it could generate not just a large amount of revenue but with very good margins.
2014 revenue and earnings outlook
For fiscal 2014 the average revenue and EPS estimates are $185 billion, up 8% year over year, and $43.71, up 9% and almost matching fiscal 2012’s result, respectively. Apple should also have about $163 in net cash per share (not taking additional taxes for offshare cash to be brought back to the U.S.) after dividends and $16 billion in share buybacks.
With the shares trading at just over 12x fiscal 2014 EPS before taking the cash into account they are selling at a very reasonable valuation.
However, I’m not sure an iWatch or TV solution can move the financial needle enough to make a meaningful difference. They could be important for the ecosystem but on their own they may not impact the financial statement to a large degree. It is new services such as iBeacons or payments that could make a financial impact.
Stock buyback and dividends
U.S. based cash will be a limiting factor especially when it comes to increasing the dividend by a meaningful amount. Pretty much all of Apple’s U.S. generated cash goes to paying its dividend. Therefore I don’t see much more than a 10% increase to it this year and could be less since I believe Apple would like to increase it by some amount every year.
On December 5 Moody’s issued an announcement essentially warning Apple and investors (especially Carl Icahn) to not take on too much more debt. Moody’s estimates that the company could take out an additional $20 to $25 billion and not affect its AA+ rating.
I don’t see Apple management willing to risk a rating downgrade so will stay within these parameters when taking on more debt. That will limit its ability to increase its stock buyback program materially beyond the current $60 billion.
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