21 October 2009

AAPL: Financial Gauge Analysis for the September 2009 Quarter

In a previous article, we examined Apple's (NASDAQ: AAPL) Income Statement for the quarter that ended 26 September, which was the fourth quarter of fiscal 2009.  Apple's quarterly earnings increased from $1.26 to $1.82 per diluted share. 

Using the financial statements in Apple's earnings announcement, we have now updated a set of Cash Management, Growth, Profitability and Value metrics.  This post reports on the metrics and the associated financial gauge scores.

In summary, Apple's latest quarterly results has produced the following changes to the gauge scores:
  • Overall: 41 of 100 (down from 48)

We were certainly surprised that the scores fell after a clearly spectacular quarter.  The reasons why are discussed below with the financial metrics that determine the gauge scores.

If necessary, we will adjust the gauge scores after Apple files a 10-K report with the SEC.

Cash ManagementSep 2009Jun 2009Sep 20085-Yr Avg
Current Ratio1.
Debt/CFO (years)
Inventory/CGS (days)
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)28.922.622.821.7
Working Capital/Invested Capital (*)
Cash Conversion Cycle Time (days)-50.5-40.2-58.9-43.5
Gauge Score (0 to 25)13131416
* For Apple we use Shareholder's Equity instead of Invested Capital

Apple's strong Balance Sheet features zero debt, $23.5 billion in Cash and Short-term Investments, and $10.5 billion in Long-term Marketable Securities.

Current Liabilities increased $1.2 billion more than Current Assets in the last year, and this difference reduced both the Current Ratio and the amount of Working Capital.  However, the added liabilities are neither worrisome loans nor increased payments due to suppliers.  Instead, Current Liabilities grew because one of its components, Current Deferred Revenue, soared from $4.85 billion in September 2008 to $10.3 billion in September 2009. 

The increase in Deferred Revenue is a direct result of the iPhone's robust sales.  Because of subscription accounting, Apple only recognizes a small portion of each iPhone sale at the time of purchase; the remainder of the purchase price gets added to the deferred revenue account. 

Funds in this account get converted to Revenue each day, with the conversion rate set by the iPhone's two-year assumed economic life.  Current Deferred Revenue is Revenue that will be recognized in the next year.
The days of Inventory held, which is amazingly low, inched up over the last 12 months.  The increase was small, but it negatively affected the Cash Management score.

We swapped Shareholders' Equity for Invested Capital in the ratios that involve the latter term.  The way we calculate Invested Capital has often led to very low or negative figures for Apple.  The swap avoids this difficulty.

Although the concept of negative days in the Cash Conversion Cycle Time is hard to grasp, we accept it with the understanding that lower numbers (or more negative numbers) indicate better cash management efficiency.

GrowthSep 2009Jun 2009Sep 20085-Yr Avg
Revenue growth12.5%12.2%35.3%27.8%
Operating Profit growth47.5%46.3%56.6%49.1%
CFO growth5.9%62.1%75.4%65.4%
Net Income growth18.0%12.5%38.3%46.5%
Gauge Score (0 to 25)8101415
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in
Operating Profit after Taxes over the last 16 quarters.

While Apple's Revenue, Operating Profit, and Net Income growth rates are all admirable, in each case the rate is significantly less than it was a year earlier.  This is a drag on the Growth score.

In addition, the Revenue-to-Assets ratio has fallen substantially, perhaps because so much Revenue has been deferred.

Finally, growth in Cash Flow from Operations did not come close to matching Net Income growth.  We would normally find this troubling; however, we believe the modest Cash Flow growth is less a performance issue and more an artifact of Apple changing how it accounts for fixed income securities.

ProfitabilitySep 2009Jun 2009Sep 20085-Yr Avg
Operating Expenses/Revenue79.0%80.0%80.7%83.4%
ROIC (*)
Free Cash Flow/Invested Capital (*) 36.9%45.1%47.8%35.5%
Accrual Ratio24.1%19.7%8.7%9.2%
Gauge Score (0 to 25)12131416
* For Apple we use Shareholder's Equity instead of Invested Capital

We're impressed with Apple's success at keeping its costs down and margins high.  The returns (income and free cash flow) on Equity are superb.  The Accrual Ratio is oddly high, which would ordinarily raise a concern about earnings quality.  However, the Accrual Ratio seems to be adversely affected by the same change mentioned above to fixed income securities accounting.

ValueSep 2009Jun 2009Sep 20085-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)811169

Over the four quarters of fiscal 2009, Apple's share price skyrocketed from $114 to $185, and this increase put a lot of downward pressure on the Value gauge.  The score would have declined further if not for the company's strong operating earnings.

OverallSep 2009Jun 2009Sep 20085-Yr Avg
Gauge Score (0 to 100)41485952

In summary, several factors combined to reduce the gauge scores even though Revenue and Earnings increased famously in the most recent quarter.

  • Because of the way iPhone sales are recorded for accounting purposes, Apple's liabilities increased and certain Balance Sheet ratios suffered. 
  • Growth rates were generally very good, but not quite as good as last year.
  • An earlier change in how the company accounts for fixed income securities weakened the Cash Flow figures in the current year.
  • A soaring share price put a substantial downward pressure on the Value gauge.

Full disclosure: No position in AAPL at time of writing.

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