Re-iterating Apple on the dip!

by Wayne Ferbert on October 31st, 2012

If you read our blog last week, you saw that we liked Apple on its weakness. We sold January puts that effectively give us an entry price of $547. We still like that play on this weakness we see today.

The January $565 puts are now trading around $22 - up from $18 on Friday. We would say we like them even more now. Or you can think about the $555 and sell them for around $18. Your effective entry price would be $537. 

Let's examine two key questions on Apple: (1) Why is it weak right now?; (2) Can its earnings actually grow higher?

On its current weakness, I think it is mostly driven by the very average earnings quarter they just finished and the uncertainty about forward sales of its key products. It didn't help that the iPad sales for the quarter just finished came in weaker than expected.  Also, the iPad mini has had good reviews this week - but they were not stellar. The screen and price are being critiqued heavily. So, I think given the current product mix, the analysts are trying to figure out what powers the earnings going forward.

Effectively, the question is: can they earn $50+ per share pre-tax again over the coming 12 months like they just accomplished?

The analyst community is uncertain. Add the management shake-up just announced and investors get nervous. The management shake-up doesn't concern me. It looks like Tim Cook is just consolidating power in the hands of a trusted few that have a track record of delivering. 

As for the uncertainty on forward earnings, that really is the 2nd question above. You have to have a view on forward sales of key products to have an opinion on whether the company can grow its earnings. 

I believe it can grow higher. I believe the iPad mini sales are actually just in time to save the iPad sales numbers. The iPad sales declined not because it wasn't a great product - but because it was already saturating the market. And it is not the kind of product replaced every 1-2 years like a smart phone. 

The iPad mini will, I believe, fill in the sales gap the normal iPad would have suffered. With the iPad mini, I believe the total combined iPad product line sales can exceed 100 million units in the coming 12 months. That is a significant number and necessary to see this company exceed the $50 in pre-tax earnings per share.

We already know the iPhone 5 has so much demand that they can barely keep up. They will sell a record number of iPhones this coming 12 months - at a very attractive margin. Again, the iPhone is the straw that stirs the Apple earnings drink.

And the Apple computer line will exceed expectations in the holiday quarter. I believe the new line will be a popular upgrade path for many families and popular gift this holiday season. Apple will be able to keep its computer sales close to flat while the industry shrinks. 

I think these will combine to make for a higher earnings path for Apple. But the one thing to know: the January announced earnings will be the tell-tale sign. Weak sales announced then will fore tell the next 9 months of sales. But I think the quarter will be a blow out - assuming Apple can fill its sales channels which we know they have a good track record on.

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