A Good Apple Could Keep Tech Afloat

Regarding the slight shortfall in Mac units, analysts seem unconcerned, given the earlier-than-expected introduction of desktop and laptop Macs powered by Intel (INTC Quote) chips. I get the impression that analysts feel there may have been some lost sales to customers waiting for an Intel-based machine. I think the shortfall was likely due to the overwhelming demand for iPods. Apple Stores were mobbed at Christmas, and I think there was just less of a focus on selling computers and more of a focus on getting iPods out the door. For example, each store set up a separate table just to ring up iPods.

Beyond the quarterly numbers, the questions for AAPL relate to future iPod and Mac demand. Analysts bumped up their iPod shipments for every quarter in 2006 and are expecting another year of big growth. Reports of unmet demand at many consumer electronics retailers have led to the assumption that a backlog in demand still exists at the consumer level. Given the strength in sales at the Apple Stores, I wonder how much of that supposed demand has already been met. That said, with 42 million iPods sold, we are far from saturation. At most, U.S. penetration is around 10%, and the rest of the world lags well behind. Also, AAPL did not introduce iPod upgrades at Macworld, suggesting that plenty of demand remains in the current form factor. It also leaves the ability to drive demand with further upgrades certain to come later this year.

AAPL also seems more focused on supplying its own iPod accessories. Accessories were a big seller during the holidays, and Macworld Expo accessory introductions -- such as the iPod FM Remote and iPod A/V connection Kit -- tell me that AAPL wants to capture more of the multi-hundred million-dollar revenue stream in accessories. Typically, accessory purchases carry higher margins, so this could be a source of upside surprise in the future, if my theory is correct.

As for Mac demand, I think the Intel transition and the halo effect will prove quite positive during 2006. AAPL has always had great success with new Mac introductions due to the willingness of its loyal customer base to upgrade. Credit Suisse First Boston analyst Robert Semple has published some excellent research on this phenomenon and notes, "[I]n the five major form factor upgrades since 2001, according to our criteria, Apple has averaged a 129% sequential increase in unit shipments along with a 26% ASP increase." Add in the much greater awareness of AAPL products today, and this transition could be among the best ever. Plus, I continue to believe that, in the consumer market, the shift toward using computers for broadband Internet and digital media has reduced the importance of the operating system and increased the importance of the application software. AAPL has a big edge in digital media applications, so the leveling of the playing field against Windows makes a pickup in market share for Macs a real possibility.

With all that as background, being long AAPL, I do worry that we could get a sell-the-news reaction to the earnings report, particularly as it relates to margins and guidance. Heading into this week, AAPL is already up 19% this year after more than doubling off the summer low. My confidence in predicting the short-term reaction to AAPL's first-quarter 2006 earnings report is low. However, based on my belief that demand for iPods and accessories will remain strong and Mac sales will boom, I think downside is limited. Based on what I know now, I'd be a buyer below $80, where I think 20% upside would exist for AAPL shares over the next six to nine months.