Analyst: Here Are 3 ‘Interesting Tidbits’ From Apple’s June Quarter
Following Apple’s (NASDAQ:AAPL) release of its fiscal 2014 third quarter earnings results, Wells Fargo analyst Maynard Um has issued his usual “’First Look’ Picture Book” research note that highlights the “interesting tidbits” in the Cupertino-based company’s 10-Q filing. In case you missed it, Apple’s fiscal third quarter revenue hit the high end of its guidance at $37.4 billion, a year-over-year increase of 6 percent. Quarterly net profit grew by about 20 percent to $7.7 billion, or $1.28 per share. Gross margin was also up from 36.9 percent in the year-ago quarter to 39.4 percent in this year’s June quarter. As usual, senior analyst Um and his colleagues identified several tailwinds and headwinds that affected Apple’s gross margin in the June quarter.
Apple’s gross margin of 39.4 percent beat Um’s estimate of 38.3 percent and as a result, the analyst concluded that Apple saw some “incremental benefits from items such as commodity costs and improved leverage.” While Um believes that Apple’s June quarter gross margin saw a net gross benefit of 120 basis points (bps) from various accounting items, he also believes that this implies that there is less opportunity for gross margin upside in Apple’s current quarter.
1. Warranty Claims and Accruals
Among the various accounting items noted by Um was a decrease in Apple’s warranty accruals by $497 million compared to the March quarter. Um estimated that the decrease in Apple’s warranty expenses benefitted the company’s gross margin by 130 bps, or $0.08 in EPS. However, while warranty accruals were a tailwind for Apple’s June quarter, the situation will likely be reversed in the September quarter, when accruals typically rise above claims due to the release of new products. This trend can be seen in the chart above that was provided by Um and his colleagues. For this reason, Um estimated that the increased warranty accruals would likely be a headwind of around 160 bps for Apple’s gross margin in the fiscal fourth quarter.
2. Deferred Margin on Component Sales
Another accounting item identified by Um was a drop in the deferred margin on component sales, which improved Apple’s component cost advantage in relation to the components’ spot prices. For the third consecutive quarter, Apple’s deferred margin on component sales dropped. Um believes that the $255 million drop in deferred margin on component sales benefitted Apple’s gross margin by approximately 70 bps, or $0.04 in EPS. While Um doesn’t anticipate that this tailwind will carry over into Apple’s current quarter, he doesn’t believe that it will be a headwind in the September quarter either.
3. Accrued Marketing and Selling Expenses
Not all of Apple’s accounting items operated as tailwinds for Apple’s gross margin in the June quarter. Um estimated that an increase in accrued marketing and selling expenses of $283 million may have been an 80 bps headwind to gross margin, or a decrease of $0.05 in EPS. Um believes this headwind will carry over into Apple’s fiscal fourth quarter, albeit to a lesser extent at 30 bps.
Despite Apple’s better-than-expected gross margin in the June quarter, Um has previously stated that Apple will eventually have to choose between average selling price/margin and units, since the analyst doesn’t believe the iPhone maker can maintain both. The Wells Fargo analyst currently has a “valuation range” of $86 to $96 on Apple shares and a “Market Perform” (Hold) rating. Wells Fargo’s investment thesis on Apple states that “the positives of potential near-term ‘s’ cycle gross margin improvements and new products are balanced against potential gross margin pressure later in the year, limited amount of incremental market cap opportunity in the existing product segments, and a potential balance of power shift back to wireless operators from handset vendors.”
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