Apple Hits a High, but Fails to Convince Big Investors

Shares of Apple ( AAPL) hit a one-year high in intraday trading Monday, propelled by enthusiastic chatter about a new powered-up chip for its high-end computers -- announced at a conference Monday -- and a promising venture into the online music business. But though Mac lovers may see reason to applaud, heavy hitters in the fund world aren't exactly jumping out of their seats.

That's true even though the stock is up 38% from April 28, the day it announced an online music store that could boost sales of computers and iPods, its line of portable music players. After hitting a 52-week high on Monday, shares later retreated amid broad-based tech selling, ebbing 14 cents, or 0.7%, to $19.06.

At a developer's conference, Apple touted upcoming new desktop computers as "the world's fastest." The boxes will contain the new PowerPC G5 chip manufactured by IBM, which can process twice as many bits of data at a time compared to existing desktop processors. Apple also previewed the new version of its desktop operating system, "Panther," which will be available by the end of this year. Yet fund managers seem unmoved by speculation about Apple's pending product rollouts.

"Apple clearly has great customer loyalty. But they just can't compete with Microsoft ( MSFT) and Intel ( INTC)," says one fund manager who asked to remain anonymous, calling Apple "a classic example" of a company on the losing end of long-term competitive pressure. "It's been a value stock for a long time. I think we made the decision a long time back on sticking with winners," says the manager.

Analyst John Park, who covers the stock for Independence Investments, says buysiders are likely to stay on the sidelines until Apple can show progress on profitability and market share.

On both fronts, Apple is facing headwinds. To be sure, the computer maker managed to turn a slim first-quarter profit -- $14 million on $1.48 billion in sales -- after two back-to-back quarterly losses.

But it's grown steadily less profitable over the past three years: Its net profit margin ebbed to a mere 0.9% as of the March 2003 quarter, compared to an 11% margin back in June 2000.

It's an unsavory picture on market share, too. According to Gartner, Apple's piece of the worldwide PC market, measured in units, has fallen steadily. In the first quarter of 1998, its share stood at 3%; it declined to 2.3% in 2001 and has subsequently edged down to 2.1% in the most recent quarter.

Niche Markets Showing No Signs of Turnaround

Meanwhile, two of Apple's biggest markets -- education and advertising -- have taken a beating and show no signs of getting off the mat. IDC has predicted the U.S. education market will shrink 16% in the 12 months through September 2003.

Advertising remains touch and go. "If I thought the ad market was turning around, Apple could be a play on that," says Vincent Colicchio, co-manager of the All-American Equity ( GBTFX) fund. "But Adobe ( ADBE) cutting its numbers last week tells me there's not a turnaround."

Against that backdrop, the G5 chip likely won't be enough to force a turnaround. After all, prices for the gussied-up computer that incorporates the silicon -- the PowerMac G5 -- start at $1999. "Given how weak the market is, I don't see the volumes being very exciting, no matter how good the product is," says Colicchio.

"I mean, this is a niche company, and where the niche is weak it's not going to get a lot of interest from the Street," he says of Apple. "Not to mention that from the competitive standpoint it has higher costs than Wintel."

At Merrill Lynch, Michael Hillmeyer has been equally skeptical on the expenses front. "Apple's higher costs force it to charge more for its products than similarly equipped Wintel boxes, thus limiting the company's ability to retain market share," he said in a research note Monday. Hillmeyer has a sell rating on the shares and Merrill has not done recent banking for Apple.

Retail Stores Take a Toll

One particular area of concern: As is the case with Gateway ( GTW), the cost of operating Apple's retail stores takes a toll on margins, as Hillmeyer has pointed out. Before Apple opened any stores, back in fiscal 2000, operating expenses amounted to about 19% of sales of $8 billion, producing a 7% operating margin.

But since then, Apple's sales have fallen off to around $6 billion while its relative expenses have increased, partly because it has steadily expanded its retail base to over 50 stores since opening its first outlet in May 2001. Operating expenses now equal around 27% of sales, leaving an operating margin of only around 1%.

That leaves Apple only barely in the black, with plans to open another 17 stores by the end of this year.

As for Apple's online music venture, analysts are generally taking a wait-and-see approach, though most assume sales won't offer much of a lift to a total revenue base of nearly $5.8 billion over the past year.

To be sure, the early response has been promising: Late Monday Apple said customers have so far downloaded over five million songs from its iTunes music store, at a price of 99 cents each. The same fund manager who sees Apple as a marginal player says he's "kind of intrigued" with the potential of a new market, though it's not enough to make him purchase shares.

But Colicchio, another buysider, says it just shows Apple is "grasping for growth. The fact that they're looking in that direction tells me they're in search of a business model. Which is fine; they should do that -- but it tells me there's a lot of risk," he says.

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