Apple Product Sales Miles Ahead of PC Peers'

 Apple (AAPL) reported solid fiscal fourth-quarter earnings that were within the range of our expectations. After considering the company's usual conservatism with its forward-looking forecasts, its revenue outlook is a bit better than our prior estimates, though its earnings-per-share forecast was disappointing, as gross margins associated with new products will be lower than historical levels. We plan to maintain our fair value estimate.

Revenue in the September quarter was $36 billion, ahead of the firm's forecast of $34 billion discussed in July and modestly ahead of Wall Street consensus estimates of $35.8 billion. By product line, iPhone sales of 26.9 million units were modestly below our expectations, but we believe sales at these levels still indicate a solid iPhone 5 launch at the tail end of the quarter. IPhone revenue of $17.1 billion was in line with our forecast, thanks to a 2% average selling price increase to $636. Mac sales were a surprising bright spot, as laptop PC unit sales and revenue were respectively up 31% and 47% sequentially and 9% and 17% on a year-over-year basis.

These results are miles ahead of the dismal results reported by many other firms in the PC supply chain. Even if the PC end market were healthy, these sequential improvements were also substantially above Apple's typical seasonal patterns. We view Mac strength as a positive sign for Apple's narrow economic moat, as iPhone and iPad users may be trading up to Mac PCs, thereby incorporating more Apple products into the company's ecosystem.

The iPad was the big disappointment, as the firm only sold 14 million units in the quarter. We expected a weak iPad quarter, since CEO Tim Cook indicated that the firm sold its 100 millionth iPad a couple of weeks ago, which implied sales of no more than 16 million in the September quarter. Apple hinted that it will start to see a seasonal decline in iPad units in the September quarter, as educational sales spike in the June quarter before the back-to-school season, and we don't see lower iPad sales this quarter as a sign that iPad is losing its growth momentum.

Despite higher sales levels, gross margins deteriorated 280 basis points to 40%. We suspect that the decline was due to higher costs associated with the company's new products, such as the iPhone 5. Still, Apple earned a strong operating margin of 30% in the quarter, down from 33% in the June quarter. In turn, earnings per share were $8.67, well ahead of the firm's forecast of $7.65 but slightly under consensus estimates of $8.75.

For the December quarter, Apple forecasts revenue of $52 billion and EPS of $11.75. The firm typically exceeds its financial forecasts, and we calculate that it only needs to beat its sales forecast by 6% to match consensus estimates of $55 billion. We think there's a very good chance that the top line will meet or exceed these Street estimates. The company's EPS forecast of $11.75 appears light to us and is well below consensus forecasts of $15.41. The biggest concern, in our opinion, revolves around Apple's forecast gross margins of 36%, well below 40% earned in the September quarter. New products like the iPhone 5 and various new Macs are expected to carry higher component costs than prior models. The iPad Mini will also be well below Apple's corporate gross margin average, although at a $329 price point and given the specifications of the product (like an older processor), we still think the Mini has similar gross margins to the larger iPad, which we estimate to be around 20%.

Despite the disappointing gross margin and EPS forecasts, we're still encouraged by Apple's expected top-line growth. We also anticipate that Apple will focus on cutting costs, especially as new products mature and certain supply constraints ease in the months ahead, in order to see modest gross margin improvement over the next few quarters.

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