Best Ideas Newsletter and Dividend Growth Newsletter portfolio holding Apple (AAPL) posted decent fiscal fourth quarter results Monday, finishing off a tremendously profitable 2013 fiscal year. Revenue increased 4% year-over-year during the fourth quarter to $37.5 billion, easily exceeding consensus estimates. For the full-year, the iPad maker’s revenue grew 14% to $170.9 billion—more revenue than Chipotle, Netflix, Tesla, and Facebook combined. Earnings per share easily exceeded consensus estimates but fell 4.7% year-over-year to $8.26. For the full-year, earnings per share declined 10% to $39.75. However, Apple generated $45.5 billion in free cash flow for fiscal 2013, up about $3 billion year-over-year and equal to 27% of revenue.
iPhone Refresh a Success
Apple sold 33.8 million iPhones during the quarter, an increase of 26% year-over-year. The iPhone 5s remains in high interest, and CEO Tim Cook noted that the firm was unable to satisfy demand. In fact, Cook noted that there is still an order backlog. With a fresh operating system and fantastic hardware specs, the 5s is on track to break sales records, offering tangible evidence to counter the growing notion of Apple’s popularity decline. A satisfaction rate of 96% and a loyalty rate of 92% also counter claims about Apple’s growing unpopularity.
Apple’s iPhone ARPU (average revenue per unit) declined sequentially to $577, versus ARPU of $582 in the third quarter and ARPU of $618 in the fourth quarter of 2012. Unfortunately, we think this number will continue to decline as Apple pushes the lower-cost 4s and 5c in the marketplace. Yet, we doubt either model will cannibalize 5s sales, so we think the lower cost sales will represent incremental revenue that Apple may not capture otherwise.
Given Cook’s persistent claim that there will be some fascinating new products in fiscal year 2014, we’re optimistic that the launch of the 6 will be positive in the back half of the year.
Surprising iPad Resiliency
Without question, the iPad remains the marketplace leader in tablets. Apple didn’t have a product refresh during the fourth quarter, but it managed to fend off a unit sales decline by pushing the product through enterprise and education channels. We love the idea of iPads replacing textbooks, and we think once schools make the change, they will not go back. This translates to years and years of recurring revenue.
Image Source: AAPL
Looking ahead, the newly introduced iPad Air and iPad Mini with retina display will provide the company with a nice product line-up heading into the holiday season. With four models now available (the original iPad Mini, iPad 2, iPad Air, and iPad Mini with retina display), we think Apple will capture market share, though ARPU will face some pressure.
iTunes: A Viable Business on Its Own
Though the iPad and iPhone steal the attention at Apple, and rightfully so, revenue generated at iTunes/software continues to soar, up 22% year-over-year during the fourth quarter to $4.3 billion. The launch of iTunes Radio provides another positive revenue growth catalyst in terms of both advertising revenue generated on the service as well as a boost to content sales.
iTunes Radio has thus far generated 20 million unique users in the US. This figure is fantastically positive for Apple, but it certainly doesn’t bode well for competitor Pandora (click ticker for report: ). We’re waiting for the release of October listener metrics that will help us gauge just how much market share Apple’s new product is stealing. September listening metrics included less than two weeks of competition from iTunes Radio.
Capital Allocation
Apple has come under scrutiny from legendary activist investor Carl Icahn for not returning enough cash to shareholders. Icahn has suggested the firm adopt a $150 billion stock buyback program and has pitched the idea to CEO Tim Cook. Though we don’t believe Icahn’s wish will come true, we think management will increase capital returns in coming quarters. Still, the firm repurchased $5 billion in stock during the period (click here to see how share repurchases impact fair values).
As for the quarterly dividend, it remained unchanged at $3.05 per share, though that figure is materially higher than it was a year ago. Given Apple’s robust cash balance and its ability to quickly replenish its coffers, the dividend is poised for significant increases in coming years.
Robust Holiday Quarter Guidance
For the first quarter of Apple’s 2014 fiscal year (the holiday quarter), the firm expects to generate revenue of $55-$58 billion at a gross margin of 36.5%-37.5%. The revenue guidance implies growth of 1%-6% and is mostly above the consensus estimate of $56.7 billion.
Though the gross margin looks weak on the surface, CFO Pete Oppenheimer noted that Apple is deferring $900 million in revenue due to its inclusion of productivity applications on new products. Without this deferral, the first quarter gross margin forecast would be around 38.5%, which is a much stronger number.
With new iPhone models, compelling new iPads, and refreshed, less expensive, and more powerful MacBook Pros, we think there could be some upside to the sales forecast.
Valuentum’s Take
We continue to be fans of Apple and its tremendously profitable business model. With a large cash balance and another year of $40 billion+ in free cash flow around the corner, Apple remains a sizable position in both of our actively-managed portfolios.
RJ Towner owns shares of the following companies: AAPL