Apple Posts Record Q1 On Strong iPhone Sales, Margin Gains

AAPL: Apple logo

Apple (NASDAQ:AAPL) announced a strong set of Q2 FY2014 results on Wednesday, beating guidance on both revenues and gross margins. The company saw its revenues grow 5% year-over-year to$45.6 billion in the second quarter, which turned out to be its best non-holiday quarter ever. The top-line outperformance was primarily driven by a strong showing by the iPhone, which sold well across geographies and price ranges. Each of the three iPhones in the market sold better than their predecessors in their respective price ranges, and the two new carrier signings in NTT Docomo and China Mobile (NYSE:CHL) provided Apple with a strong boost in Japan and China. While Apple’s revenues in China grew 13% year-over-year, Japan posted an even stronger 26% growth over the same period last year. iPhone growth in emerging markets was especially promising, with unit sales in the BRIC countries setting a new quarterly record on strong adoption of the cheaper iPhone 4S. The stronger-than-expected iPhone contribution helped Apple’s gross margins increase by over 180 basis points to 39.3%.

See our complete analysis for Apple stock here

iPad decline

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However, iPad sales disappointed as revenues declined by 17% year-over-year, which the company attributed primarily to inventory changes and a tough comparison to last year. The company exited the holiday quarter with supply almost in balance with demand for the iPad, unlike last year when the iPad mini was highly supply-constrained. As a result, Apple’s sell-in figures for the iPad took a hit, with the company working to reduce its channel inventory last quarter. The underlying demand was much better, as sell-through declined by only 3% over the same period last year. Going forward, such inventory changes are unlikely to recur. Either way, the iPad performance isn’t nearly as big a driver of the company’s value as the iPhone, accounting for only about 11% of our $640 price estimate for Apple’s stock.

iPhone’s outperformance in emerging markets

On the other hand, the iPhone contributes almost half of the company’s value by our estimates. With the high-end smartphone market nearing saturation amid moves by carriers such as Verizon and AT&T to cut down on subsidies, it has become imperative for Apple to find new sources of growth in international markets. The iPhone’s performance in developing markets last quarter should therefore be heartening for investors, given how well the China Mobile deal and increased marketing around the entry-level iPhone 4S propped up Apple’s fortunes in these markets. Apple said that iPhone sales in China, Brazil, Indonesia, Poland and Turkey grew by double-digits year-over-year and more than doubled in India and Vietnam. However, a higher mix of iPhone 4S sales caused its ASP levels to decline by over $40 sequentially to less than $600.

Value in Apple’s stock

The company also increased the size of its capital return program from $100 billion to $130 billion, to be executed by the end of next year. That the $30 billion increase will be almost entirely used to repurchase shares shows how bullish management is about the company’s long-term potential. We see this as a smart move given that Apple’s shares are currently trading at depressed levels relative to our $640 fair price estimate for the company. With a view to increase liquidity and make the stock more accessible to retail investors, Apple also decided to split the stock 7 to 1, effective June 9.

Our price estimate for Apple doesn’t take into account the impact of new product categories that the company has said it will enter this year. Although the company hasn’t officially declared any new products yet, there is speculation that two of those categories could be TVs and wearables (possibly watches). These new categories are unlikely to add a lot of near-term value to Apple given the company’s significant current market capitalization, and the potential lack of a subsidy-based model that could incentivize faster upgrades of these new products. However, on their own, these products could be multi-billion dollar businesses for Apple and strengthen the iOS ecosystem further, thereby driving additional sales of existing products such as the iPhone or the iPad. For more information on these possibilities, see iWatch Could Add $50 Billion To Apple’s Value and Apple Television Could Be A $50 Billion Opportunity, May Not Drive Apple’s Value By Much.

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