Why Apple's 10% Gap Up Is Just the Beginning

Apple blew away expectations for quarterly results with revenue of $45.6 billion on the strength of iPhone sales and iTunes-related revenue. The quarter was expected to be weak for the company, as it's after the Christmas season yet before the launch of the iPhone 6, but the company really delivered on both results and capital allocation. The stock is gapping up almost 10% at $570, but with the iPhone 6 release coming later this year, it is very likely that this is just the beginning.

The iPhone number was good, but don't ignore iTunes.
iPhone sales figures were impressive, with 44 million phones sold into the channel, but iTunes revenue of $4.6 billion was up 11% year-over-year and is growing at twice the rate of the overall top line. To put this in perspective, the lower-margin Mac business was virtually flat, selling 4.1 million units in the quarter compared with 4.0 million units a year ago. iTunes is a derivative of the hardware business, but is now even more important from a profit standpoint because those profits are higher-margin. Apple previously announced that it operates the iTunes business at breakeven, but with just the $4.6 billion in revenue from iTunes software and services, the company's entire operating expenses structure is covered. It seems unlikely that this is running at breakeven.

Massive capital allocation plan scares away shorts
Apple announced changes to its capital allocation plan that will send short-sellers running for the hills. The buyback is being boosted by $30 billion, up from $60 billion to $90 billion. However, the company is doing three additional things: it is raising its dividend by 8% to $3.29, it will raise the dividend annually going forward, and the stock is being split 7-for-1. The stock split, theoretically, does not increase the value of the company, but in practice, stock prices tend to rise after a split announcement.

iPad numbers weren't as bad as they seem at face value
When selling products through resellers, companies have an opportunity to manage earnings results by stuffing the channel with product. However, when channel inventory is reduced, the numbers look ugly, and this was the case with iPad figures in the quarter. Last year, Apple sold 19.4 million iPads into the resellers distribution channel, which subsequently sold about 18 million, thereby increasing channel inventory by 1.4 million units. This year, Apple sold 16.4 million units into the channel, and the channel sold 17.5 million units to consumers, effectively decreasing channel inventory by 1.1 million units. So, the real sell-through decline was only 3%.

10% gap up is just the beginning
The iTunes business is probably higher-margin than hardware, and growing much faster than the top line, because there are back-half product catalysts. Today's gap up is probably just the beginning. Apple managed to produce massive upside amid concerned investors, while also deploying capital in several shareholder-friendly ways. It would have been nice to hear about wearable computing products or electronic payments, but considering the sheer number of announcements and the strength of the results, maybe it's better to save a few press releases for a rainy day.  

Your credit card may soon be completely worthless
The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them -- but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless -- and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days. Click here to watch this stunning video.

The article Why Apple's 10% Gap Up Is Just the Beginning originally appeared on Fool.com.

David Eller has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story