The Day Ahead: Resist the Urge to Dial Up Apple

 | Apr 24, 2013 | 8:00 AM EDT  | Comments
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Apple's (AAPL) earnings are pretty much only useful for keeping your analytical skills sharp. I mean, really -- were you the cowboy who went long this stock at 6x estimated fiscal 2015 earnings, hoping that "baked into the cake" logic would play out? I hope not, because the market certainly told you that could be an ill-timed decision.

To little ol' me -- and I may be in the minority here -- the massive attack on Apple's share price in the past six months is more a reflection of quickly evolving fundamental trends, and less a reaction to management's lust for holding on to cash flow that is supposed to be earmarked for investment or for shareholders. So any shareholder-friendly initiative, buyback or dividend should be met with a chilly reception -- and it was after-hours Tuesday.

This is how I assessed the situation -- well, that, in addition to remembering how I almost got burnt to a crisp recommending Apple into the last earnings report.

You are probably wondering if Wednesday is the day to reconnect with this once-trusted friend -- a friend that brought forth vast paper wealth from 2004 to mid-2012. I know you want to pick the bottom in Apple, but you should resist the urge to dial up your old flame. In the earnings report, and in the call, we were reminded of at least three key investing lessons that say Apple's story will continue to deflect negatives rather than project out positives.

1. A cheap stock could become cheaper: Apple will become less expensive as margin degradation begins to mean slowing cash-flow growth. I certainly can't see sell-side estimate revisions going higher off these numbers.

2. CEO language comparisons matter: First, Tim Cook sounded rather defeated on the press release vs. the prior quarter and investor day -- an obliterated share price and the arrival of activists will surely bring out a Debbie Downer demeanor. Second, on the earnings call, Cook led off the discussion by blaming Apple's difficulties on its past success. With Apple, the market had come to demand consistent success, and it still does in many respects.

3. Deal in the slightly knowable: The earnings call gave even fewer hints on future product launches than Apple normally does, and certainly the kibosh was put on a holiday 2013 iTV. We do know that Apple will do its incremental-upgrade thing shortly, but that isn't what Mr. Market had yearned to hear? By the way, have you ever seen an iTV build sheet? I'm guessing you haven't.

Some More Fun Stuff

• Apple had a very nice quarter in China (unlike, say, Caterpillar (CAT)).

• If you look at the large step-ups in Apple's inventory and research-and-development expenses -- a 42-basis-point rise -- it's clear that something of excitement could be in the works for the first half of 2014.

• I'm not sure why this "other income" line more than doubled for Apple in quarter, but it helped earnings beat a lowered consensus.

• Apple guided to another quarter of sequential margin degradation. It will be hard to buy the stock as the business continues to lose steam, even amid ramping talk of new product releases into the summer.

• Apple margin sanity check: Gross margin is at 37.5% vs. 37.5% guidance on the low end vs. the 38.5% Street estimate.

Why You Should Stay Clear of Apple

First, average weekly sales declined 19% in the quarter. This is an astonishing statistic that highlights pressure on average selling prices, in addition to new competitive threats.

Second, the majority of iPad Mini purchases have been from first-time iPad consumers. That's a problem, because it means a lower-margin device is the one getting immediately chosen at Apple stores. It also means an existing iPad owner sees no need for an iPad mini. Apple has dominated over the years by making people feel as if all of its products are must-haves.

Finally, I was left with the impression that, due to the nature of the product-rollout schedule, September guidance could be as disappointing as June forward numbers; note, also, that Apple is issuing realistic guidance nowadays.

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