Apple could beat 2009 revenue consensus by $900m per quarter
Four months ago, the analyst consensus estimate for 2009 had Apple earning $6.36 in EPS on approximately $40 billion in revenue. Since that time, the economy has gone through a major financial crisis, which has led many analysts to revise their estimates down quite dramatically.
As of today, the analysts are now looking for Apple to earn $5.35 in EPS on approximately $37.5 billion in revenue in 2009. The consensus has Apple literally contracting on the year -- down from $5.36 in EPS in 2008. These extraordinarily bearish consensus estimates have set Apple up to beat revenue expectations by approximately $900 million each quarter in 2009.
I expect Apple to earn about $6.63 in EPS on $41.2 billion in revenue beating expectations by $1.28 in EPS and $3.63 billion in revenue. This amounts to an average quarterly beat of $907 million in revenue and $0.32 in EPS. Even before this recent bout of downward revisions to the estimate, I saw the consensus as already pricing in a moderate to severe recession.
The biggest problem with the current consensus estimate is that it either contemplates flat growth in unit sales across all of Apple?s product lines (including Macs and iPhones), or it fails to realize that Apple has a massive current deferred revenue pot that it will fully recognize in 2009. Sitting in a small corner of Apple?s financial statement, current deferred revenue is something that can easily be overlooked by analysts who either don?t fully analyze the company, or don?t normally cover the company.
Due to the subscription method of accounting for iPhone and Apple TV sales, Apple recognizes the revenue it receives from the devices over a 730-day period (rather than at the point of sale). At the end of every accounting period, Apple reports its total current and non-current deferred revenue for the iPhone and Apple TV on its consolidated schedule of deferred revenue.
Current deferred revenue is revenue that Apple will recognize over a 365-day period from the date of the financial statement, while non-current deferred revenue is revenue that Apple will begin to recognize starting 365 days after the date on the financial statement.
Thus, at the end of Apple?s fiscal fourth quarter, current deferred revenue is literally revenue that Apple will recognize in the ensuing fiscal year. At the end of 2007, for example, Apple had $346 million in current deferred revenue which it got to recognize equally over the 365 days of fiscal 2008. That averages to about $86.5 million that Apple was able to recognize for each quarter of 2008 without having to sell a single item in the period. Now compare that number to 2009.
Current deferred revenue at the close of Apple fiscal Q4 2008 was $3.518 billion?over 10 times the amount going into fiscal 08. This means that if Apple didn?t sell a single product in 2009, it would automatically get to recognize $880 million per quarter (compared to the $86.5 million that Apple got to recognize each quarter in 2008). Now here?s where things get complicated, and where the flaw in the analyst consensus is revealed. It?s important to follow this point very closely.
Since Apple went into 2008 with a revenue benefit of $346 million, while going into 2009 with revenue benefit of $3.518 billion, one must back out these benefits to get an idea of what the consensus is really indicating about Apple?s business in 2009. By backing out these benefits, one gets a clearer picture of how Apple actually performed in 2008 (without regard to benefits from sales in 2007) and how the analysts think Apple will actually perform in 2009 (without regard to benefits received from sales in 2008). By doing this, one will be able to determine the actual growth rate estimates in unit sales and revenue by the analysts. It basically answers the question of what will 2009 sales contribute in total revenue minus deferred revenue benefits.
Here?s the basic math. If one subtracts the $346 million benefit Apple received in 2008, Apple would have reported $32.133 billion in revenue ($32.478 billion - $.346 billion). If one subtracts the $3.518 billion revenue benefit that Apple will recognize in 2009 from the analyst consensus estimate of $37.57 billion in revenue, he or she would arrive at a $34.052 billion figure. What this tells us is that the analysts believe that Apple will grow its revenue by only $1.919 billion in 2009 when backing out the current deferred revenue benefit.
That?s a mere 5.9% growth rate in revenue despite the fact that Apple?s Mac sales are growing at over 3 times the industry average, and despite the fact that iPhone unit sales grew over 400% in Q4 alone. Even iPod sales are still growing at nearly 5-8% per period and iTunes continues to grow at over 30% on a YoY basis each quarter. Also, it?s important to note that any time Apple sells over 5 million iPhone within any given quarter, Apple not only gets to recognize $400 million in revenue in that particular period, but it gets to recognize roughly $400 million in revenue each quarter for 7 quarters thereafter. This literally means that iPhone sales in Q1 alone could add about $1.6 billion in revenue for the year, which would make up almost all of the $1.919 billion in sales growth that the analysts are expecting for 09.
This fact single-handedly suggests that the consensus is plainly factoring in negative revenue growth for all of Apple?s products in 2009 save the iPhone. Because even if Apple sells only 2.5 million iPhones in Q2 after selling 5 million Q1, Apple would have already surpassed analyst revenue growth estimates for 2009?even if sales are exactly flat across all of its other product lines. Basic common sense would suggest that such estimates are entirely irrational. While a moderate to deep recession will undoubtedly affect Apple?s business, the natural growth rate and penetration in even a flat economic environment should offset the negative effects of a slowdown.
Disclosure: Andy owns long term 2009 and 2010 call options in Apple. The information contained in this post is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
As of today, the analysts are now looking for Apple to earn $5.35 in EPS on approximately $37.5 billion in revenue in 2009. The consensus has Apple literally contracting on the year -- down from $5.36 in EPS in 2008. These extraordinarily bearish consensus estimates have set Apple up to beat revenue expectations by approximately $900 million each quarter in 2009.
I expect Apple to earn about $6.63 in EPS on $41.2 billion in revenue beating expectations by $1.28 in EPS and $3.63 billion in revenue. This amounts to an average quarterly beat of $907 million in revenue and $0.32 in EPS. Even before this recent bout of downward revisions to the estimate, I saw the consensus as already pricing in a moderate to severe recession.
The biggest problem with the current consensus estimate is that it either contemplates flat growth in unit sales across all of Apple?s product lines (including Macs and iPhones), or it fails to realize that Apple has a massive current deferred revenue pot that it will fully recognize in 2009. Sitting in a small corner of Apple?s financial statement, current deferred revenue is something that can easily be overlooked by analysts who either don?t fully analyze the company, or don?t normally cover the company.
Due to the subscription method of accounting for iPhone and Apple TV sales, Apple recognizes the revenue it receives from the devices over a 730-day period (rather than at the point of sale). At the end of every accounting period, Apple reports its total current and non-current deferred revenue for the iPhone and Apple TV on its consolidated schedule of deferred revenue.
Current deferred revenue is revenue that Apple will recognize over a 365-day period from the date of the financial statement, while non-current deferred revenue is revenue that Apple will begin to recognize starting 365 days after the date on the financial statement.
Thus, at the end of Apple?s fiscal fourth quarter, current deferred revenue is literally revenue that Apple will recognize in the ensuing fiscal year. At the end of 2007, for example, Apple had $346 million in current deferred revenue which it got to recognize equally over the 365 days of fiscal 2008. That averages to about $86.5 million that Apple was able to recognize for each quarter of 2008 without having to sell a single item in the period. Now compare that number to 2009.
Current deferred revenue at the close of Apple fiscal Q4 2008 was $3.518 billion?over 10 times the amount going into fiscal 08. This means that if Apple didn?t sell a single product in 2009, it would automatically get to recognize $880 million per quarter (compared to the $86.5 million that Apple got to recognize each quarter in 2008). Now here?s where things get complicated, and where the flaw in the analyst consensus is revealed. It?s important to follow this point very closely.
Since Apple went into 2008 with a revenue benefit of $346 million, while going into 2009 with revenue benefit of $3.518 billion, one must back out these benefits to get an idea of what the consensus is really indicating about Apple?s business in 2009. By backing out these benefits, one gets a clearer picture of how Apple actually performed in 2008 (without regard to benefits from sales in 2007) and how the analysts think Apple will actually perform in 2009 (without regard to benefits received from sales in 2008). By doing this, one will be able to determine the actual growth rate estimates in unit sales and revenue by the analysts. It basically answers the question of what will 2009 sales contribute in total revenue minus deferred revenue benefits.
Here?s the basic math. If one subtracts the $346 million benefit Apple received in 2008, Apple would have reported $32.133 billion in revenue ($32.478 billion - $.346 billion). If one subtracts the $3.518 billion revenue benefit that Apple will recognize in 2009 from the analyst consensus estimate of $37.57 billion in revenue, he or she would arrive at a $34.052 billion figure. What this tells us is that the analysts believe that Apple will grow its revenue by only $1.919 billion in 2009 when backing out the current deferred revenue benefit.
That?s a mere 5.9% growth rate in revenue despite the fact that Apple?s Mac sales are growing at over 3 times the industry average, and despite the fact that iPhone unit sales grew over 400% in Q4 alone. Even iPod sales are still growing at nearly 5-8% per period and iTunes continues to grow at over 30% on a YoY basis each quarter. Also, it?s important to note that any time Apple sells over 5 million iPhone within any given quarter, Apple not only gets to recognize $400 million in revenue in that particular period, but it gets to recognize roughly $400 million in revenue each quarter for 7 quarters thereafter. This literally means that iPhone sales in Q1 alone could add about $1.6 billion in revenue for the year, which would make up almost all of the $1.919 billion in sales growth that the analysts are expecting for 09.
This fact single-handedly suggests that the consensus is plainly factoring in negative revenue growth for all of Apple?s products in 2009 save the iPhone. Because even if Apple sells only 2.5 million iPhones in Q2 after selling 5 million Q1, Apple would have already surpassed analyst revenue growth estimates for 2009?even if sales are exactly flat across all of its other product lines. Basic common sense would suggest that such estimates are entirely irrational. While a moderate to deep recession will undoubtedly affect Apple?s business, the natural growth rate and penetration in even a flat economic environment should offset the negative effects of a slowdown.
Disclosure: Andy owns long term 2009 and 2010 call options in Apple. The information contained in this post is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.
Comments
_____________
1. First and formost, using 4Q iPhone sales to predict future sales is as big a flaw in logic as other analysts not taking into account Apple's deferred revenue. Is that quoted 400% increase in unit sales a year-over-year number, or 3Q to 4Q number? Remember that Apple all but stopped selling the 1st gen iPhone for the last month of 3Q. They had run out of iPhone while they ramped up production of the new version. The new iPhone and low supply led to a huge pent up demand in the 4th quarter.
2. A second mistake is tying EPS entirely to revenue growth and ignoring expenses as if they have no effect. Lower EPS could be due to lower revenue as the article states, or higher expenses. Apple has stated that it's margins were going to be lower due to product transitions. The MB/MBP have transitioned to the new manufacturig process. There could be other transitions coming. Lower margins and selling at the same or higher prices (in the case of the MB) means higher expenses. It's may be a small effect, but the point is that EPS to revenue is not a 1-to-1 relationship.
Don't get me wrong, I agree that the analysts are selling Apple short (no pun intended). But the only thing worse than an Apple technology fanboy is a financial fanboy who owns long-term call options on Apple.
So lets stop saying good things about and then the stock prices will go up to where they really belong.
Realistically, Q1 EPS will not be better than last year. The remainder of the year I am much more optimistic though.
While I agree with the basic premise, there are a few problems:
1. First and formost, using 4Q iPhone sales to predict future sales is as big a flaw in logic as other analysts not taking into account Apple's deferred revenue. Is that quoted 400% increase in unit sales a year-over-year number, or 3Q to 4Q number? Remember that Apple all but stopped selling the 1st gen iPhone for the last month of 3Q. They had run out of iPhone while they ramped up production of the new version. The new iPhone and low supply led to a huge pent up demand in the 4th quarter.
2. A second mistake is tying EPS entirely to revenue growth and ignoring expenses as if they have no effect. Lower EPS could be due to lower revenue as the article states, or higher expenses. Apple has stated that it's margins were going to be lower due to product transitions. The MB/MBP have transitioned to the new manufacturig process. There could be other transitions coming. Lower margins and selling at the same or higher prices (in the case of the MB) means higher expenses. It's may be a small effect, but the point is that EPS to revenue is not a 1-to-1 relationship.
Don't get me wrong, I agree that the analysts are selling Apple short (no pun intended). But the only thing worse than an Apple technology fanboy is a financial fanboy who owns long-term call options on Apple.
To answer a few of your issues...
1. I'm not using Q4 iPhone sales to predict future sales. First, the 400% increase YoY is in Q4 (Apple's recently reported quarter). Second, to say that there was not at least equal pent up demand for the iPhone going into Q4 of 2007 is being outright unrealistic. In many ways, Q4 2007 saw much larger pent up demand for the iPhone than Q4 2008. After all, Q4 2007 was basically the debut quarter of the iPhone period. Thirdly, the 400% increase is merely meant to illustrate that iPhone sales are growing period. The consensus, as is demonstrated in the articles, assumes an extremely low growth rate for all of Apple's product lines. So to presuppose that I use Q4 as a proxy to predict Q1 sales is to make a straw man out of my argument. That 5 million iPhone number that I quote comes from the bearish consensus. I'm looking for 7-8 million iPhones.
2. There are so many problems with your second point and I'll try to outline each. First, what expenses are you talking about? Cost of Goods Sold or Operating Expenses? You ambiguously state the term "expenses" in an equivocal fashion. If you assume that I don't think that operating expenses are going to increase moderately in 2009, then you're mistaken. As a matter of fact, my operating expenses estimate is above Apple's own guidance! If you assume that I don't expect the cost of goods sold to increase as a result of the new manufacturing process, which Apple has harped about incessantly, then you're sadly mistaken. They're baked into the estimates.
But the expense ambiguity aside, I would like to point out the monumental flaw in your reasoning. You really need to Google and read about the concept of cost-volume profit analysis. EPS earned per dollar of revenue is not a function of gross margin percentage, operating expenses or gross margin contribution alone. Revenue to EPS may or may not be a 1 to 1 relationship and it has very little to do with one element standing alone. EPS is a function of overall contribution known as gross margin minus operating expenses. There are circumstances where lower gross margins can lead to significantly higher EPS if operating expenses as a percentage of revenue drops precipitously, or if overall gross margin contribution (not gross margin percentage) rises significantly. And there are circumstances where higher gross margins can in fact lead to lower EPS. If the growth in OpEx as a percentage of overall revenue exceeds the growth rate in gross margins, then EPS per dollar of revenue earned will be lower than in the previous period.
Let me try and illustrate the way one must think about EPS and its ratio to revenue. You mention that gross margins might fall due to the increase in COGS as a result of the manufacturing process of the new unibody macs. And because of that increase in COGS and decrease in gross margin, EPS won't necessarily move up with revenue. Nothing can be further from the truth. There are circumstances where EPS could rise dramatically as a result of the larger overall gross margin contribution to operating income, and there are circumstances where EPS will fall due to the increase in OpEx.
Here's an example where EPS rises with the same revenue number, but where gross margins decrease!
Scenario 1: Suppose John sells 4 oranges for $5 and that it costs John $2 to produce those oranges. In this scenario, John generated $20 in revenue, a gross margin percentage of 60%, cost of goods sold of $8 and overall gross margin contribution of $12. Yet, it cost John $8 to rent a store where he sells these oranges, and this makes up his total operating expenses. In this scenario, John produces income of $4.00. If 4 shares are outstanding in John's company, then John produced $1.00 in EPS.
Scenario 2: Suppose John sells 4 oranges for $5 and that it costs John $3 to produces those oranges. In this scenario, John generated $20 in revenue, had a gross margin percentage of 40%, cost of goods sold of $12 and an overall gross margin contribution of only $8. Yet, it cost John only $3 to buy a table where he sold those oranges. In this scenario, John produces income of $5.00. If 4 shares are outstanding in John's company, then John produced $1.25 in EPS.
Notice how in scenario 2, John made 25% more in EPS than in scenario 1 despite the fact that John had a much lower gross margin percentage in scenario than he did in scenario 1. It all has to do with overall contribution, not gross margin percentage, and operating expenses as a percentage of revenue. This is essentially the crux of cost-volume profit analysis. The good thing about Apple is that its operating expenses don't move up so dramatically. As a matter of fact, operating expenses as a percentage of revenue has been on a continuous downtrend because Apple's revenue has been increasing significantly faster than has Apple's operating expenses. Operating expenses are on a constant rise as is Apple's revenue. It just so happens that the growth rate in revenue is far outpacing OpEx as a percentage of revenue.
So. Don't just assume that because gross margins decrease that EPS earned per dollar of revenue cannot increase in dramatic fashion. Nothing can be further from the truth. As a matter of fact, it is very often the case that when gross margins decrease, EPS earned per dollar of revenue happens to go up. Why? Because many companies will cut prices on products to drive up sales which results in lower gross margin percentage but substantially higher overall gross margin contribution. If Apple cut the price of iPhone in half, its gross margin percentage on the iPhone would decrease, but the total contribution from iPhone sales could increase significantly.
3. You say the only thing worse than an Apple technology fanboy is a financial fanboy who owns long-term call options on Apple. This is ad hominem tu quo que. Focus on attacking the argument instead of the author. I say this writing this response to you from my Lenovo x41! Why can't I own a position in Apple because I find the analysis compelling. Why do you automatically assume that I make a case because I own shares? That makes no sense at all. I have no affect on the stock price and my publishing this article will in no way stop hedge funds from redeeming. I write this exclusively for the benefit of retail investors.
If I tell someone that they ought not to smoke because smoking causes cancer, my argument is no more or less cogent if I myself happen to smoke. Attack the argument, not the person making the argument.
Here's the bottom line. A dramatic rise in Apple's revenue without an associated rise in OpEx would almost always lead to a higher EPS to Revenue ratio. Gross margin percentage is tiny part of an equation. Gross margin contribution and OpEx as a percentage of revenue is far more important in determining EPS to Revenue ratios.
Andy, I think your Q1 numbers are unrealistic from a purely casual observation standpoint. Q1 doesn't have Q4's pent-up demand for the 3G iPhone; much more than 4MM units would surprise me. The pent-up demand for the laptops could help grow from 1.68MM units to closer to 2.5MM, although desktops should stay flat around 1MM. iPods would surprise me if they were a significant growth driver, but it is possible they would sell 13MM units.
Realistically, Q1 EPS will not be better than last year. The remainder of the year I am much more optimistic though.
1. "Q1 doesn't have Q4's pent up demand for the 3G iPhone" Let me ask you the following question. When Apple announced the iPhone in January 2007, would you say that the pent up demand for the iPhone was more for the period between June 29, 2007 - September 30, 2007 than it was for the period between October 1, 2007 and December 31, 2007? I think almost everyone could have made the same exact argument last year that they are making this year. There were lines around the block when the iPhone first came out, there was 6 months of pent up demand, etc. etc. Yet, lets take a look at the difference. In Q4 2007, Apple sold 1.1 million iPhones. In Q1 2008, the same exact situation we're in now, Apple sold 2.3 million iPhones. It sold more than double the amount of iPhone than they did in the quarter where there must have been huge pent up demand. I really wouldn't focus too much on this whole pent-up demand issue.
Here's another very important point. Apple sold the 3G iPhone for only 68 days last quarter. In Q1, Apple will see the iPhone for over 90 days. The amount of time the 3G iPhone will see in Q1 is about 27% more than it did in Q4. The iPhone came out on July 11, no iPhones sold between July 1-10 (first 10 days of the quarter) and Q4 ended early this year - on September 27.
Finally, I was able to predict iPhone sales within 8% last quarter where the analysts missed by an average of 72%. The analysts think that Apple will see about 5 million iPhones in Q4. That should tell you something.
2. Do you really believe that Apple is only going to sell 13 million iPods in Q1? Please tell me this is a typo and you meant 23 million units.
Andy, I think your Q1 numbers are unrealistic from a purely casual observation standpoint. Q1 doesn't have Q4's pent-up demand for the 3G iPhone; much more than 4MM units would surprise me. The pent-up demand for the laptops could help grow from 1.68MM units to closer to 2.5MM, although desktops should stay flat around 1MM. iPods would surprise me if they were a significant growth driver, but it is possible they would sell 13MM units.
Realistically, Q1 EPS will not be better than last year. The remainder of the year I am much more optimistic though.
I wouldn't under estimate the iPods. The touch could be a very strong seller.
To answer a few of your issues...
Sorry, I was not trying to discredit your analysis. As I stated, I agree with your conclusions, just a little less enthusiastically. Also, the article focused entirely on the revenue side, so it was impossible to know what other factors you considered (operating expenses, margins, etc). (If that info was in your graphic, oops. AI's article graphics are blocked from viewing at my current location!) Thank you for clarifying in your reply. And yes, you can decrease margin and make up for it in volume to get high EPS. One way you point out is to decrease price to increase volume, but didn't Apple increase the price of the MB which generally isn't a good way to increase volume.
I appreciate the additional information you provided about what went into your analysis. I was attempting (perhaps poorly) to play devil's advocate. Your reply also had a few "could" statements pointing out where some of the variables are that I felt were missing from the original article. (I'm an engineer, which means I like to know what my variables are.) That made the article read to me at least as overly bullish.
Finally, I apologize if my last statement offended you. It was meant tongue-in-cheek (note the goofy smiley!) in that many people here get labeled "fanboy" for being strong Apple supporters. It was not intended as a personal insult.
Its hard to come out and say apple will sell 20+% more computers while other tech companies are cutting estimates across the board (intel, etc).
I dont necessarily think people are going to trade down and buy a PC because they are cheaper..but i do think some people will postpone their purchase until the markets cool down somewhat.
intereting analysis...maybe a best-case scenario..but interesting.