Best Ideas Newsletter holding Apple (click ticker for report: ) posted solid results Tuesday afternoon. Apple exceeded consensus earnings expectations earning $10.09 per share versus an expectation of $10.07. Revenue grew 11% year-over-year to $43.6 billion, exceeding consensus estimates by over $1 billion. Free cash flow totaled $31.6 billion during the first 6 months of the fiscal year, an increase of 10% compared to the same period a year ago.
Importantly, the company also announced expanded intentions to repurchase shares and boosted its dividend 15%. The firm’s buyback was raised to $60 billion (from $10 billion), and it will also use $1 billion annually to offset restricted stock grant dilution. Apple sneakily increased its share count 5% over the past five years thanks to generous restricted share unit grants. We’re happy to see the firm (finally) offset this dilution.
In order to fund the buyback program, Apple will take on some debt to avoid repatriating its foreign cash. We believe this is a prudent move because we think Apple will be paying an exceptionally low interest rate, and the firm will be able to maintain ample financial flexibility.
While we applaud Apple’s management team for finally doing something with its tremendous cash balance, we’re disappointed that the company gave such a wide time frame. We believe, and obviously Apple’s management agrees, that shares are incredibly cheap at this point. If we were in CFO Peter Oppenheimer’s position, we’d announce a more aggressive share tender (perhaps at $450) or announce that the company will aggressively repurchase shares immediately—not over the next few years. Raising the dividend 15% gives the company a more compelling yield, and perhaps even a floor in the share price. However, with shares so inexpensive, we’d rather the company allocates excess capital to the more tax-efficient share repurchase.
Aside from announcing a new outlook on capital management, the firm reported another strong quarter. In addition to strong free cash flow and revenue growth, the firm had solid expansion across its product lines. Mac revenue jumped 7% while the broader PC market declined 14% (according to IDC), suggesting the company is gaining market share. Although the Mac accounted for just $5.4 billion in sales, it is clear market share gains are part of our broader thesis that Apple can infiltrate the enterprise.
iPad sales jumped 40% year-over-year to $8.7 billion, driven in large part by the popularity of the iPad Mini. We’ve seen this story play out at Apple before with the iPod. The initial device is incredibly successful, and then the firm releases another form factor that is also popular with consumers. Although the Mini is likely cannibalizing some revenue and margin, the device keeps users locked in the iOS ecosystem and can lead to further Apple purchases, in our view.
The iPhone’s revenue increased just 3% year-over-year to $22.9 billion, as unit sales grew 7%. This suggests lower ARPU, but we believe much of the mix has to do with iPhone 4 expansion abroad. Again, we like the move because it leads to the introduction and (hopefully) stickiness of the Apple ecosystem. In our view, worries over the iPhone’s “coolness” are completely out of line. Just yesterday, AT&T (click ticker for report: ) reported 6 million smartphone activations in the first quarter. Of these 6 million activations, 4.8 million were iPhones—or an implied activation market share of 80%. Such robust market share doesn’t suggest weakness—if anything it speaks to the resiliency of Apple to sell its products against Samsung and other Android competitors. Rarely do we see such a disconnect between real, hard facts and media perception. Maybe a larger screen for iPhones is in the works, but it doesn’t seem to matter. iPhone seems to be the preferred product.
Speaking of the product pipeline, CEO Tim Cook mentioned that the firm is working on new products and categories that will be released in the future. Speculation is pointless, in our view, but we believe it remains one of the best features of Apple’s business model—the firm could release a revolutionary product at any juncture. In fact, we’re happy to be out of the loop regarding new products because Apple’s competitors will rush to make similar offerings. When iWatch rumors hit the wire, competitors rushed to create their own iterations.
Looking ahead, the firm forecasted flattish revenue year-over-year for the quarter at $33.5-$35.5 billion, with gross margins of 36%-37%. The light revenue guidance may imply that a product refresh lurks just around the corner, or Apple may be revisiting its prior strategy of sandbagging guidance. Regardless, based on the stock’s reaction to positive results and capital allocation, it appears Mr. Market wants to exclusively focus on the bear case for Apple, ignoring reality. Nevertheless, we remain confident in the company’s future, and we will hold on to shares in the portfolio of our Best Ideas Newsletter.