Apple Recovery: What Needs to Happen (Update 1)

Updated from 9:45 a.m. EST to provide Barclays comments regarding product plans on the the third page.

NEW YORK ( TheStreet) -- Apple ( AAPL) has had a rough go of it in recent weeks and months. However, there are signs that the stock is capitulating. The road to recovery has multiple phases, and it starts with returning more cash to shareholders.

In a research note, Topeka Capital Markets analyst Brian White lays out a three-step process to building more value for Apple shareholders. The first phase talks about Apple's massive cash hoard, which has been the subject of much angst and controversy in recent weeks, as Greenlight Capital's David Einhorn and others draw attention to it.

Last year, Apple announced it would be returning $45 billion in cash to shareholders, as part of a dividend and buyback program, with a quarterly dividend of $2.65 per share. While that was a good start, Apple's cash hoard has grown significantly higher, and investors are clamoring for Apple to return more.

"We think of Apple as being able to generate approximately $50 billion in free cash flow per year," White wrote in his report. "We continue to believe that Apple should increase its quarterly cash dividend payout to $3.75 to $5.00 per share (annual yield of 3.3% to 4.4%)." White rates Apple shares a "buy" with an $888 price target.

At Apple's shareholder meeting and on its first-quarter earnings call, Apple management, including CEO Tim Cook and CFO Peter Oppenheimer, both said Apple is thinking about its cash hoard and what to do with it. Cook described the talks as "very, very active," hinting that something would be done to appease shareholders.

White noted that aside from Apple raising its dividend, it has the capacity to raise its repurchase program to as high as $100 billion as part of a five-year plan.

Given Apple's management is conservative with its cash, I, for one, don't see anything that aggressive coming out of Cupertino.

Next, White noted that Apple's profit cycle has to hit a trough, then bounce back up. White estimates that Apple's operating profit and earnings per share will decline 19% year-over-year in the second quarter of fiscal 2013, before bouncing back in the latter part of the year.

Analysts surveyed by Thomson Reuters expect Apple to earn $10.18 per share on $42.8 billion in revenue. A year ago, Apple earned $12.30 per share on $39.19 billion in sales, so earnings have come down drastically. In order for Apple to grow earnings, it must innovate, and that's where the third and perhaps most important part of Apple's recovery comes from.

Apple's primary profit and revenue driver is the iPhone, but the many on Wall Street believe Apple is hurting itself by not introducing a lower-cost iPhone, to cater to emerging markets. " The introduction of a lower priced iPhone this year will allow Apple to tap into 60% of the smartphone market that the Company is currently missing out on," White wrote.

There is a mixed opinion about whether Apple should introduce a lower-cost iPhone, and whether it would hurt Apple's brand or not. At a recent investor conference, Cook sidestepped this issue, only saying Apple would never make bad products. "The only thing we'll never do is make a crappy product," Cook said. "We're going to make a great product. And so that's the only religion that we have is we must do something great, something bold, something ambitious. We want the customer to be at the center of it. We want to enrich people's lives."

Expanding Apple's presence, especially in China, is another way for Apple to get its groove back. A deal with China Mobile ( CHL) would go a long way toward putting the iPhone in the hands of more customers. Earlier this year, Cook and China Mobile's Chairman Xi Guohua discussed "matters of cooperation," but so far, nothing has come of that.

It doesn't mean there won't be anything, however. China Mobile has plans this year to substantially increase its capital expenditures, as it builds out its 4G network, and many believe that is a sign that the iPhone is coming to the world's largest mobile carrier later this year.

White said China Mobile had 95 million 3G subscribers at the end of January, as part of its 715 million subscribers, so the opportunity for Apple and the iPhone is tremendous. Cook has acknowledged this fact in the past, saying China is an incredibly important market for Apple. "It's clear that China is already our second largest region as you can see from the data that we have given you and it's clear, there is a lot of potential there," Cook said on Apple's most recent earnings call.

Lastly, Apple needs to come out with new products, to show that innovation is alive and well in Cupertino, and not just as its competitors, such as Samsung, Google ( GOOG), and others.

The oft-rumored iWatch, along with an Apple-branded television set, would go a long way toward cooling the worries that innovation is dead. Samsung has confirmed that it's working on its own smart watch, adding credence to the suspicion that Apple has been working on something of its own.

Barclays Capital analyst Ben Reitzes wrote he thinks Apple is six months away from Apple's new iPhones and iPads, which will help boost sentiment around the stock. "We believe that Apple's shares are close enough to the new announcements to begin anticipating improvement within 6 months -- even with the prospect of below consensus fiscal 3Q (June) revenue and EPS guidance," Reitzes wrote in his note. He rates Apple "neutral" with a $530 price target.

It's been a rough few months for Apple, since the introduction of the iPhone 5, the iPad mini, and other products. Apple is now the underdog, and has traditionally come out on top when it plays that role.

This time looks to be no different.

-- Written by Chris Ciaccia in New York

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