Tue, 24 Jan 2012
Some upside remains in Apple shares, but the acceleration of the iPhone and iPad businesses has sent the stock closer to fair value, says Morningstar's Mike Holt.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.
Apple had another blowout quarter, and I am here today with senior analyst Mike Holt to get his first take on the results and what he thinks is next for the tech giant.
Mike, thanks for talking to me.
Michael Holt: Thanks for having me.
Glaser: So was there anything bad in this quarterly report?
Holt: Well, there are so many good things to focus on, nothing bad is sticking out. I mean when you see 37 million iPhones and 15 million iPads being sold, that's a blockbuster quarter.
Glaser: So there really seems like there was strength across a lot of different businesses. So let's take a look at each of them somewhat briefly. First is the iPhone. Was the launch of the iPhone 4S successful for Apple?
Holt: Absolutely, and it's incredible success. If you look at the quarter before this, the September quarter, they sold 17 million iPhones. So to go up to 37 million sequentially in one quarter that's a huge jump; that's a screaming success for the product launch.
Glaser: So now is that due to further adoption in new markets, in emerging markets? Is it due to people trading up from their existing iPhones? What's driving that big increase?
Holt: With that big of an increase, it's a combination of all those things. So there are on more carriers around the world; even in the U.S., you see they've launched on more carriers after historically just being with AT&T. But it's also just there was pent-up demand from the existing user base, and then there was a lot of new interest from people who didn't have an iPhone before.
Glaser: Now in the tablet space, what's happening with the iPad? Has it seen any headwinds from lower-priced competitors like the Kindle Fire yet?
Holt: Less than we've expected. There is room. We've seen this on the smartphone side that there's room for more than one player, so it won't just be Apple dominating forever; there's room for Android devices, for the Kindle Fire. But what we see now is that Apple is doing just fine despite the competition.
Glaser: What's happening with their Mac sales?
Holt: Those are strong, too. There's a nice Halo effect; they've brought a lot of new users in on the iPhone and iPad, and some of those are opting for the Mac. But if you look at how this revenue breaks down, 50% of the revenue from the quarter was from the iPhone, and if you include the iPad, over 70% of the revenues are accounted for with just those two devices. So that's where we are really focusing our energy.
Glaser: So what does this move toward even more mobile devices do for the firm's margins?
Holt: Surprisingly, they actually went up. A lot of people are concerned that maybe the way Apple would drive volume going forward is to move into lower-priced segments. They are offering of course the iPhone 4S, but they are still offering the iPhone 4 and the 3GS as well.
What we take away from this quarter is that, that did not drive down the average sale price. So the demand is really being fueled by demand for the highest-end device right now. Now that may change in the coming quarters, but for right now, it's still a very strong trend.
Glaser: So with this higher profitability, huge sales, just adding to that ever-growing pile of cash in Cupertino, any news on what they are going to do with this? Any thoughts on what they could do with all those cash?
Holt: No news on what they are going to do. They are saying that they are considering options, which we would hope they would be doing. It’s a material amount of money and has been for some time, but it doesn’t strike me that they'll be blowing it on big acquisitions, but how they decide to return that to shareholders could take the form of buybacks, a dividend. A lot remains to be seen, and the timing is very uncertain.
Glaser: But they sound like they are more open to some of those share buybacks or dividends in the future.
Holt: We don’t know specifically what they are open to, but they definitely seem to have a much more open mind about doing something with the cash that may not be just acquisitions. And it probably is a function of how much cash they have accumulated. They don’t need the same safety net that they've had in the past.
Glaser: So looking forward, though, is this kind of growth rate sustainable? What can help drive Apple's growth, and on the other side, what could really keep that growth tempered down?
Holt: It was a blockbuster quarter, but even sequentially when we look at the next quarter, we are expecting a big pullback in terms of the number of devices sold, because they are not benefiting from a new product launch over the holiday season as much. So typically, you will see this seasonality, and we are definitely going to see that again this year.
That being said, the momentum is very clear on iPhone, and they are launching into new markets. For example, in China, the iPhone 4S wasn’t available until January. So we are not going to see any of those numbers until the next quarter. There is a lot of positive momentum. We might see the next-generation iPad, maybe the iPad 3 or whatever they decide to do there. These things will carry the positive momentum. It looks good. But I wouldn’t expect this type of quarter even going into the second quarter of the year.
Glaser: Do you think newly announced initiatives like textbooks on the iPad and allowing people to do desktop publishing of iBooks is going to have a major impact on the bottom line, or is that just icing on the cake?
Holt: I think they are good initiatives, but not really things that are moving the needle from our perspective. It makes sense that you want to target and get these products in the hands of people in high school and college and create those habits, and maybe those are your future consumers, but there is plenty of growth to be had outside of those initiatives. So they are a more icing on the cake.
Glaser: Finally, when looking at valuation, does Apple look attractive today?
Holt: Our fair value estimate is $530, and so there is still some upside, but it’s approaching our fair value estimate and getting much closer than it has been ever.
Glaser: Well, Mike, thanks for your thoughts on Apple. I’m sure we will be hearing from you next quarter.
Holt: Thank you.
Glaser: For Morningstar, I’m Jeremy Glaser.