Apple Earnings OK, Guidance Poor, New Controversy

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Apple reported largely inline December quarter results. Revenues of $54.5 billion were barely shy of consensus and EPS of $13.81 were barely above consensus. Gross margins exceeded guidance and were close to the most optimistic street estimates. Product sales were about as expected except for Macs, which missed by lot.
Guidance was below the street as usual. There was hope that guidance would be closer to the analyst estimates which would have eased concerns about demand for iPhones and iPads, gross margins, and negative datapoints from the supply chain.
The actual earnings and guidance were greeted by a quick 6% drop in the shares. I’d call that fair as essentially the quarter and guidance left the recent controversies intact and provided no relief for the bulls. The way the street works that gets the stock back to the low end of the recent range. Not great but not a disaster if you believe as I do that underlying product demand is growing.
On the call, the company explained its new approach to guidance. Here is the exact quote:
“In recent years our guidance reflected a conservative point estimate for results every quarter that we have reasonable confidence in achieving. Going forward, we plan to provide a range of guidance that reflect our belief of what we are likely to achieve. While we cannot forecast with complete accuracy, we believe we are likely to report within the range of guidance we provided.””
This comment dropped the stock another 6% to where it trades now as the conference call concludes, $459, down 11% from today’s close. The issue here is that management seems to be saying that previously guidance was “conservative” and now it is “what we are likely to achieve.” Management denied to expand on this quote when given a couple of opportunities in Q&A to admit that the shift still leaves guidance as “conservative.” I do think the second attempt by an analyst left open the possibility that guidance is conservative.
The reason this matters is that low-balling guidance meant that this quarter’s guidance disappointment probably wasn’t that bad as the actual report would be close to analyst estimates. If this quarter’s guidance is real, then analyst estimates are going to have come down sharply. Current FY13 consensus is $48. That would imply $24 in second half earnings if guidance is taken at face value, a 33% gain year over year.
However, with a just reported flat quarter, guidance for -20% quarter, and ongoing worries about demand due to the supply chain datapoints and production cuts, analysts and investors are never going to believe a quick rebound to 33% growth.
If this year ends up with EPS in the low $40 range, down 5%, the shares look pretty cheap as long as growth resumes. With $144 in cash, call it $120 after-taxes, the stock is trading at $340 against $40 in operating EPS. Very cheap if growth resumes. But we aren’t going to know whether growth resumes for a few months.
I believe growth will resume. I also believe that guidance is going to prove conservative again. Underlying product demand looks a lot better than the stock price to me. Until I am proven right, however, the stock is in the penalty box with minimal upside. I think it is worth holding on but expect the bumpy ride to continue and when growth does resume think $500s not $700s.
Apple is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov. Apple is a net long position in the Entermedia Funds. Steve is portfolio manager of Entermedia, owns a controlling stake in the Funds’ investment management company, and has personal monies invested in the Funds.
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Google Concerns Ease

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Google (GOOG) has consistently produced 20-25% growth for the last three years but the stock has gone nowhere. Investors have worried that the growth will slow due to competition from social media (Facebook) and the shift from desktop to mobile search. Over the past week, both of these issues have been addresses with a favorable outcome for GOOG investors.
First, Facebook announced its new search product. The product looks interesting and seems like it could be a success for the company but it does not go head-to-head with GOOG in web search. Rather, it provides search just for Facebook’s extensive data on its users. Facebook’s announcement was still pressuring GOOG shares but I think any material impact on GOOG’s growth from Facebook is still many years in the future.
The bigger issue holding back GOOG shares for the past year has been whether the company could manage the shift to mobile computing. The issue is that ads in mobile (smartphones and tablets) are priced much below those on the desktop (PCs and laptops). For example, GOOG has been reporting 25-40% growth in paid clicks (searches for which GOOG is paid) but at an average cost per click (price GOOG receives for the ad) falling 5-20%.
Investors have been concerned that this mix shift would hurt margins as the cost to obtain mobile clicks is higher. In addition, the outsized growth in paid clicks is bound to slow as penetration of mobile devices matures. GOOG’s latest earnings report showed progress on the mobile monetization challenge. Paid click growth remained robust at 24%, whiles cost per click fell 4% adjusted for foreign currency. The cost per click decline slowed from an 8% decline last quarter. Wall Street greeted these numbers favorably, pushing the stock up over 6% to anew high for 2013. Heading into the report, GOOG shares were down in 2013 despite the steady market rally.
I think that Wall Street is beginning to accept that GOOG is well-positioned for mobile monetization. The steady growth in paid clicks and stabilizing pricing for the ads sets GOOG up well to sustain 20% earnings growth for the next few years. If investors believe in the growth, the stock trades at a very reasonable valuation, particularly after adjust for about $150 in cash on the balance sheet that is contributing very little to earnings with interest rates near 0% on short-term investments.
GOOG could make around $45 this year and $54 in 2014. Put a 15 multiple on $50 in EPS and you get $750. Add in the cash balance an price target of $900 is quite achievable.
The bottom line is that GOOG had a quarter. Revenue, EPS , and margins met or slightly exceeded expectations. Key drivers of the search business showed that the outlook for the next couple of years is better than the bears having been touting. I think this quarter might be the one that allows GOOG to turn the corner with investors. That will surely be the case if next quarter shows further improvement on the paid click/cost per click front. I suspect it will and GOOG shares will finally live up to their potential.
Google is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov. Google is a net long position in the Entermedia Funds. Steve is portfolio manager of Entermedia, owns a controlling stake in the Funds’ investment management company, and has personal monies invested in the Funds.

Large Cap and Value to Start 2013; Models Put in Mixed 2012 Performance

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There are no changes to the signals from Northlake’s models for January. For the second consecutive month, the Market Cap model favors large caps. The Style model remains on a Value signal, as it has since August 2012. As a result of this month’s signals, there will be no changes to client investments based on the models. Positions in the S&P 500 (SPY) and Russell 1000 Value will be maintained (IWD).
January will mark the fifth month in the last six that the Market Cap model has recommended large caps. This follows a long period where the model rarely favored large caps. In fact, since an 11 month run for large caps to finish 2007, the Market Cap model has only favored large caps in two other months prior to the recent shift. While you should never outguess your model, I believe this could be the start of a period where large cap remains in favor. The economy and monetary policy have stabilized along with the markets. GDP growth is slow but consistent and interest rate and inflation look set to remain low for several years. In addition, the dollar has weakened somewhat especially relative to the euro as the European Central Bank has taken steps that have defused the sovereign debt crisis. This backdrop favors large caps which can easily finance their balance sheets, grow modestly, and take advantage of scale in global markets. As an aside, I still see lots of potential potholes in the market outlook that could create the quick, sharp, short drops we have often seen these last few years. I like being in mode stable large caps when volatility is high.
The Style model changed little for January and remains with a strong value signal. There was a small shift toward growth as the U.S. dollar is now down slightly on a year-over-year basis. Growth companies, particularly those in technology, do a lot of business outside the U.S. and benefit from increased competitiveness and currency translation when the dollar is falling.
The models put in a mixed performance in the fourth quarter and 2012. The Style model did well in both periods. For the fourth quarter, the value signal gained approximately 1.5% against a loss of one half of one percent for growth and 1% for the S&P 500. For 2012, the Style model earned over 15%, about 2% ahead of the S&P 500.
The Market Cap model matched the market in the fourth quarter but lagged for 2012, gaining over 10% but trailing the S&P 500 by about 3%. Most of the miss occurred in the second quarter when mid caps lagged the June rally that followed the worst month of the market, a decline of 6% in May.
SPY and IWD are widely held by clients of Northlake Capital Management, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Filings can be found at www.sec.gov. SPY is short position in the Entermedia Funds, serving as a hedge against long positions. Steve is the portfolio manager of the Entermedia Funds, owns a majority stake in the Funds investment management company, and has personal monies invested in the Funds.