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Apple - Forget the Third Quarter, Guidance Is Key

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Apple (NASDAQ:AAPL) is set to report Q3 2013 earnings this afternoon after the market close, and around half of (surveyed) Wall Street analysts expect the company to post a year-over-year contraction on the bottom line.  The Cupertino, California-based tech titan has experienced more than its fair share of controversy and derision over the past several months, as the slowing pace of development as well as macroeconomic frailty have contributed to slumps in device sales and, notably, new product releases.  The company has failed to announce a new product over the past three months and hasn’t released a breakthrough product in the three years since the release of the first iPad.  Continual rumors of new and innovative devices have done little to assuage investors’ fears of stagnation in the company that once exemplified American ingenuity in the world of technology.  The constant disappointment in Apple has left it with one of the lowest price-to-earnings ratios among the top tech contenders, however, and a relatively quiet contingent of investors view the stock as being significantly undervalued.
Apple stock reached a year-to-date low of $385.10 in the buildup to Apple's Q2 earnings call but rallied sharply shortly afterwards, despite a call that was considered disappointing by many observers.  Despite the fact that Apple outperformed expectations, the company still posted its first year-over-year earnings decline since 2003.  The stock was range bound as ennui-stricken investors failed to find inspiration amidst those new software elements on the offer at the Apple Worldwide Developers Conference.  Apple also invited criticism when it was accused of pursuing semi-legal tax avoidance schemes, the condemnation of which has become a popular trend in recent years.  Through all of these struggles, however, as well as the continued lack of transparency relating to the release of new hardware, Apple actually gained around 5% between the last release and the time of writing.  CEO Tim Cook announced a stock buyback program and a release of a reasonably substantial dividend payout to holders of common stock that may have encouraged the investors to maintain the stock’s value despite the fundamental concerns that have resulted in a 20% decline in value this year alone. 
This decline leads one to believe that the market is nothing if not myopic.  The current creative slump in which Apple is mired is not a new phenomenon and should hardly be a surprising considering the six years between the releases of the first iPod and iPhones, and the three-year gap between the iPhone and the iPad (which is, for all intents and purposes, a 13-inch iPhone).  The problem facing Apple at this point is not the real pace of ‘innovative’ product output, but the relative speed of such output from its competitors.  The Samsung (KRX:005930) Galaxy series is a notable example of a line of devices that has recently appeared on the scene and that possesses the capacity to challenge the iPhone’s dominance.  Google’s (NASDAQ:GOOG) Nexus and Sony’s (NYSE:SNE) Xperia are both products that look to draw market share away from Apple in one of the fastest-growing technology sectors.  The difference between these companies and Apple is, at its base, a matter of corporate philosophy (and capex allocation), as noted by Apple in its latest advertising campaign.  The desire to “…spend a lot of time on a few great things…” has been the primary drive behind Apple’s flagging stock price in recent months but has, in the past, resulted in timeless and innovative products that invariably invigorate the faithful.  Apple’s competitors, however, have long sought to cast a wide net in the hopes that one of a multitude of product releases will provide competition for the worlds second largest company (by market cap).
The (likely) dwindling creative hiatus will have taken a toll on Apple’s earnings in the most-recent quarter, though the magnitude of the inevitable quarter-over-quarter drop remains in question.  Gross margins are expected to have dropped year-over-year by over 5% into a range between 36% and 37%, though many now expect a number on the high end of that range.  Deteriorating margins on sales are thought to be a result of competitive pricing as other companies (as mentioned earlier) have moved on formerly Apple-dominated market sectors, of increasing costs on the production end, and of the existing product mix that includes near-obsolete devices.  Were earnings per share to simply meet expectations, the company would post a year-over-year EPS decline of nearly $0.50.  The stock has been gifted a tailwind in the form of an impressive iPhone sales number from Verizon (NYSE:VZ) in the company’s recent earnings call, which, if matched by other such retailers, could help to offset the preponderance of negative data many expect from this afternoon’s report.
There is a high level of anticipation surrounding this earnings call, though very little of the focus will be placed on the actual earnings data from the June quarter (unless, of course, the data is very bad or exceptionally good).  Guidance for the next quarter will provide investors with a limited, but valuable, understanding of the expected release dates for products that at present remain in development.  As noted by Toni Sacconaghi, an analyst with Sanford C. Bernstein & Co., in a recent Forbes piece, relatively strong guidance for the near quarter would suggest significant releases in the near term, plus shipments of new products to begin in September.  Poor guidance for the fourth quarter would, of course, be indicative of a continuing lag in product releases.
Though some of the many rumors regarding potential impending projects from Apple have gained traction, investors have no great deal of insight as to what is coming and when it will arrive.  A boost in guidance could still fail to generate a lasting uptick in stock price if this information is not soon revealed, but many believe that any pullback in Apple should be viewed unequivocally as an entry point.  Though some argue that the titanic tech firm stands at the precipice, waiting for investors to abandon it entirely, the more likely story is that it has reached that bottom of the abyss, for now, and is poised to break out of the doldrums, with new products to be announced shortly.  Apple is near perfect in terms of creating new products that become the darling of tech-users the world over and can (and likely will) be reinstated as the most innovative firm in its field with one simple announcement.
POSITION:  Position in AAPL