Earnings Preview: Apple Inc.

Apple Inc. (AAPL) is scheduled to announce its third quarter 2011 results after the closing bell today. Over the past few days, we have noticed analysts increasing their estimates, but considering the past trends we continue to believe another earnings beat is on the cards.

Prior Quarter Recap

Apple’s second quarter 2011 earnings and revenues surpassed the Zacks Consensus Estimate handsomely on the back of strong iPhone sales, record Mac sales and increased iPad sales, as unit shipments remained robust.

Apple reported earnings of $6.40 per share, well ahead of its conservative guidance of $4.90. Earnings shot up 92.2% from $3.33 per share reported in the year-ago quarter.

Revenues jumped a staggering 82.7% on a yearly basis to $24.67 billion. The strong revenue growth was driven by increased momentum in Mac shipments and booming business by iPhone and iPad. International sales accounted for 59.0% of the total revenue in the quarter.

For further details please read: Apple Fires All Cylinders in 2Q

Current Quarter Expectations

For the current quarter, the Zacks Consensus Estimate for Apple’s earnings is pegged at $5.81, way ahead of Apple’s own conservative guidance of $5.03 per share.

Apple projects its revenues to be $23.0 billion. However, the Zacks Consensus Estimate expects Apple’s revenues to be around $24.87 billion.

Apple expects gross margins of 38.0%, reflecting approximately $55.0 million related to stock-based compensation expense. Operating expenses are expected to be $2.5 billion, including roughly $255 million related to stock-based compensation, while Other Income and expenses are projected at around $70 million. The tax rate is estimated to be about 25.0%.

Estimate Revision Trend

For the current quarter, out of the 41 analysts covering the stock, 31 analysts raised estimates and only 2 moved in the opposite direction in the last thirty days. As the estimates revision was positively biased, the Zacks Consensus Estimate increased from $5.63 to $5.81.

We note that Apple has consistently exceeded estimates in the previous four quarters. The average surprise in the preceding four quarters is a positive 16.92% and we expect another positive earnings surprise from the company.

Analysts believe strong sales performance from iPad 2 (first full quarter of sales) would drive results for the quarter. The analysts believe Apple is gaining momentum with the iPad and expanding its iPhone addressable market through additional wireless carriers in new regions and multiple carriers per country, which should sustain solid-unit growth.

The analysts also believe that Apple is gaining market share in foreign countries, especially in the Asia Pacific region. International expansion of iPad and iPhone will boost the company’s profitability over the long term. Additionally, analysts are incrementally positive on Apple’s iOS 5 and iCloud services. The latter would help the company to maintain a dominating position in digital music through iTunes, thus helping it gain an advantage over its competitors.

Positives and Headwinds: The Conclusion

We are positive on Apple’s earnings outlook and remain encouraged by the fact that third quarter estimates are going up significantly, implying that analysts see positive catalysts. The estimate revision trends and the magnitude of such revisions justify the strength of the stock.

We believe Apple will post strong results in the third quarter, based on solid sales of the iPad, iPhone and Macintosh. Apple is set to debut its much awaited iPhone 5 in September and this quarter would be the first to account fully the contribution from the iPad 2. Analysts suggest that Apple sold approximately 7.7 million units of the tablet, topping the previous three-month sales record of 7.3 million.

Lately, Apple has been entangled in a number of legal battles pertaining to patent rights with HTC, Eastman Kodak Co. (EK) and Samsung. Apple settled the patent dispute with Nokia Corp. (NOK), but will have to make a one-time payment to the latter and is to pay regular royalties going forward. Particulars of the financial terms were not divulged.

More importantly, Apple has received unfavorable verdicts in a couple of cases at the International Trade Commission (ITC). As ITC has the authority to block import of products that infringe U.S patents, the lawsuits could make a dent in Apple’s very sizeable cash balance. It may have to pay a hefty fine or a recurring license fee, which will hurt its profitability going forward.

Apple is facing tough competition in the smartphone and tablet market. The iPhone is up against cut throat competition from smartphone makers such as Samsung, HTC and LG, which are using Google Inc.’s (GOOG) android operating system.

The iPad is pitted against several new entrants, such as the HTC Flyer, Research In Motion Ltd. (RIMM) PlayBook, Hewlett-Packard Co. (HPQ) TouchPad, Dell Inc. (DELL – Analyst Report) Streak, Samsung Galaxy Tab, Cisco Systems Inc. (CSCO) Cius, Toshiba SmartPad and Acer Iconia in the tablet market. However, we believe that Apple has an advantage over the rest as most of these companies have entered the market at a later stage. Moreover, products from these companies have also received mixed reviews as against the iPad, which has enjoyed a success story so far.

Thus, we have a Neutral recommendation on Apple shares in the long term.

We currently have a Zacks #2 Rank for Apple Inc., which translates into a Buy rating in the short term.

EASTMAN KODAK (EK): Free Stock Analysis Report

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