On Monday, we will have Apple (AAPL) reporting earnings. The estimate is for $1.31 EPS and $39.8 billion in revenue. The big take away from AAPL’s earnings is going to be their gross margins and guidance. Analysts want to see how strong the margins will be for the iPhone 6. A big problem with the iPhone 5 was how it diminished AAPL’s margins. I have my own thoughts on what I believe AAPL will report and how the stock will move.
Over the last year, AAPL has gone through with a enormous share repurchase program. The effect has been seen by a sudden growth in EPS. When AAPL reported earnings in April and July 2014, EPS grew by 15% and 18% respectively. In my opinion, part of the growth was due to the buyback program. Now what do I expect AAPL to release?
I think that EPS estimates are really low. In 2013, AAPL’s EPS grew by 10% q/q; this was without their buyback program. This year, analysts are only estimating 3% q/q growth from the Q3 to Q4. I believe that this is too low for a few reasons.
• First, AAPL sold more iPhone 6 and 6 Pluses during the first weekend than the iPhone 5s and 5c.
• Looking even closer at the numbers, there was a bigger percentage of higher storage models sold this year than any other year.
• The iPhone 6 Plus accounts for around $80 more in profit ($100 higher sale price, yet only $20 in extra in the manufacturing cost).
For these reasons, profits should grow even faster between the 2014 Q3 to Q4 than the 2013 Q3 to Q4. If you go by only this then you should expect 10-15% q/q growth, which brings you to a range of $1.40 to $1.47.
There are other factors that should be considered before I can proceed with such a bullish stance. The big problem with having such a publicized product launch is that people wait for the phone to be released and then do not purchase the older model throughout the quarter. So, what could end up being the case is that the iPhone 5s and 5c sales in Q3 were very weak, and 2 weeks of iPhone 6 and 6 Plus sales will not make up for 2.5 months of weak iPhone 5s and 5c sales.
In addition to the iPhone portion of AAPL’s earnings, there are two other parts that has to be analyzed.
• First are the iPad sales. iPad sales have been slowing down, which should somewhat hurt earnings. At the same time, iPad sales only account for around 10-15% of earnings, which means even a 10% slowdown in sales would only effect AAPL’s EPS by $.01-$.03.
• Mac sales have been starting to show signs of improvement, with the IDC saying that AAPL has just become the 5th largest PC merchandiser. This should lead to 20-25% growth in the mac department.
I believe that guidance will come inline for a couple of reasons.
• I do not think that AAPL wants to set lofty expectations for iPhone sales even though it is pretty obvious that China sales will be mammoth, and the iPhone was a big success. It is smarter for AAPL to guide inline, and then have blowout earnings in January, rather than supply blowout guidance and then come inline in January. AAPL has always been very conservative, and I doubt it will change.
• There are also issues of supply constraints for the iPhone 6 and even more so for the iPhone 6 Plus. Even though there is very high demand, it is possible that AAPL will not be able to achieve that much growth y/y because they were not able to produce the iPhones.
I am long July 95 calls. I believe that it is smarter to own AAPL for the long term (6-9 months) than play one earning report, because I think that AAPL will continue to move higher over time. I own the ATM calls because I think there is a very real possibility that AAPL stays range bound for months on end. My break-even point is 107, so even if AAPL barely moves higher, I should be able to break-even on expiration, at worst.
If I were to play earnings for this quarter, I would buy a call butterfly. I do not think AAPL is going to move more than 3% and probably pins at $100 (if earnings are strong) or $95 (if they disappoint).
• So if you are bullish like me on the earnings, then I would buy a $97/$100/$103 call butterfly for $.70.
• If you think earnings will be inline and there will not be anything special, I would then buy the $92/$95/$98 put butterfly for around $.70.
• Another possibility is to sell the straddle; the implied move is around $4.50. I do not think AAPL moves more than $3 so you can probably make 20-50% on the trade. Now, even if AAPL does have a big move I do not expect it to take out $90 or $105, which means that selling a straddle should not end up being more than a 100% loss. But, I could be wrong and we could see AAPL trade at $110-$115 (in my dreams).
My estimate for AAPL earnings: $1.38 EPS and $40.5 billion in revenue