Market Analysis: AAPL 7/23/2014

Apple shares will jump to $110 this year

Apple Inc. posted another Dickensian earnings report Tuesday.

It was the best of times for Apple AAPL +2.70% investors, as its all-important iPhone posted growth of 12.7% in its fiscal third quarter.

It was the worst of times for Apple investors, too, as the company’s impressive 35.2 million smartphone units fell short of forecasts for 35.9 million.

It was the spring of hope, as Chief Executive Officer Tim Cook pointed out impressive iPhone sales growth everywhere from Brazil to Russia to China.

It was the winter of despair, as Apple once again suffered softness with its iPad line, leaving the iPhone to produce more than 50% of revenue.

What’s an investor to think of this whole mess?

Me, I’m thinking it means Apple’s stock hits $110 in the next three to six months, up from about $95 today, and keeps moving higher. That’s about a 16% gain, after having already risen 18% so far this year.

Here’s why:

1. Margin mayhem is over:

One of the biggest reasons for profits topping expectations was a widening in the gross margin, 39.4% compared with guidance of about 38%. That was also a hair above the 39.3% recorded in the previous quarter . Ever since margins bottomed at 36.9% in the third quarter of 2013 — the ill-fated period when Apple decided to stuff the product line with two new iPhones and two new iPads — there has been a big focus on margins. And a surprise that shows not only improvement year-over-year, but quarter-over-quarter, is undeniably a good thing.

2. Enterprise potential:

Sure, iPad sales were soft. But as Cook pointed out, the recently announced deal with IBM IBM +0.18% will help push enterprise tablet sales higher in the months ahead. And beyond the potential of tablets, Apple sold 18% more Mac computers compared with the same period a year earlier, a sign that while the overall PC market is flagging, Apple’s brand appeal is keeping its old-school computing business alive and well. In fact, Mac revenue was slightly lower than that of the iPad.

3. Apps as an annuity business:

ITunes and software sales continue to throw off a ton of cash for Apple. Specifically, revenue soared 12% year-over-year to almost $4.5 billion. That means software makes up 12% of total Apple revenue! Sure, Apple is indeed heavily reliant on iPhone sales to drive the bottom line, but contrary to what some investors think, the company is not wholly dependent on the upgrade cycle to keep making money. Software and app sales are perhaps most interesting to me among all the other numbers in Apple earnings — particularly when you consider that the App store has margins of around 46% . People talk a lot about Amazon AMZN -0.61% bleeding cash to build out a content business, but Apple is doing that while still making a mint on the hardware.

4. Mammoth return of capital:

Apple returned $8 billion to shareholders via stock buybacks and dividends during the quarter. A dividend of 47 cents per share times 6.03 billion shares equals $2.8 billion in dividends, leaving a mammoth $5.2 billion in stock repurchases. Or put another way, Apple took 1% of its outstanding shares off the market last quarter! And you know what? With operating cash flow of $10.3 billion in the fiscal third quarter, Apple still had wiggle room to spare. There is simply no other company on the planet that can pull off a trick like that.

5. What’s next?:

The rallying cry of the Apple bears has long been the dearth of innovation at the tech giant. However, there are a host of new initiatives in the works that may provide a big impact on the bottom line even if they don’t quite have the sex appeal some are looking for. There’s the aforementioned IBM partnership to help Apple with enterprise, the Beats headphone-and-music deal that will surely juice accessory sales, high hopes for the supersized iPhone 6 in September, and then the long-rumored and highly anticipated iWatch, or, apparently, iTime . And who knows what another 12 months will bring?

I could go on with the same old tired arguments: Apple’s $150 billion in cash and investments as a springboard to success, the fact that the company’s 2% dividend is a mere 27% of future earnings and bound for big increases, a forward P/E of 13.5 (or actually 10 when you strip out the cash).

But the bottom line is that Apple is not simply a value play. This is a stock with a lot to offer.

Improvement in margins and various areas of the business, coupled with modest new opportunities for Apple in the months and years ahead, adds up to a bullish narrative for Apple’s stock.

Still, regardless or my or anyone else’s narrative, sentiment is going to drive Apple’s shares in the months ahead. Make no mistake about that.

But in the long run, there are lots of reasons that this tech giant will keep its revenue and profits moving higher. So I expect Apple to enter next year above $110.

Article Written By: Jeff Reeves