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Apple Ripe for Strong Quarter

Music, G5 sales and a marketing deal with H-P have Wall Street abuzz about Steve Jobs' company.

After years of being lumped in with the also-rans, it may be about time for


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to crow a little.

While the company has never lost its cult following on the technology side, investors couldn't get past its dwindling market share and the faint smell of irrelevance in an era of price wars from


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. So when Apple shares started to perk up after the company announced its iTunes music store in April, many

watched from the sidelines.

Whoops. Since then, the stock has shot up nearly 75% (as of Tuesday's close of $24.12). That's true despite Apple's still-diminutive PC share: In 2003, it claimed less than 2% of the global market by units, according to estimates from Gartner Dataquest and Merrill Lynch.

Analysts say the company is on track to report healthy growth when it reports December-quarter results after the bell, courtesy of a refreshed computer line with faster processors from


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and updated Mac OS X software, as well as surging sales of iPods. Sales should total around $1.93 billion, up 12% from the prior quarter on the heels of a fat Christmas season, with earnings of 14 cents, according to consensus estimates.

Merrill Lynch -- which had dropped coverage of the stock -- issued a report Tuesday recommending investors buy the shares. In the note, analyst Steve Milunovich predicted sales will jump 18% in fiscal 2004 to $7.3 billion, while EPS will double to 42 cents. "We think Apple has gotten its act together in focusing on core markets, building a mature management team, and most important innovating again," he wrote.

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Milunovich also said an upturn in the advertising market could bode well for sales of Apple's high-end PowerMac computers based on the G5 chip, which he called "the backbone of Apple's profit." "We believe the combination of the PowerPC G5 and the Unix-based Mac OS X position Apple to profit from an economic recovery," he concluded. Merrill has done investment banking for Apple in the past year.

The December quarter will be the first "full hard quarter of G5 sales," noted fund manager Nicholas Kaiser, who holds a 2.8% stake in Apple in the

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Amana Mutual Funds Trust Growth fund. "The desktop market has been strong for them, so I expect a lot of good news."

Partly for that reason, Kaiser is looking for a "very positive surprise to the upside" in Wednesday's earnings report.

The fund manager started buying the stock several years ago when the shares were beaten down, drawn in part by Apple's significant cash hoard. At this point, Kaiser doesn't argue Apple is a bargain, but says he expects the lofty price-to-earnings ratio (currently 59, based on expected 2004 earnings) to drop as earnings accelerate.

Still, others are more cautious. At Fulcrum Global Partners, analyst Robert Cihra says he's expecting only modest growth in PowerMac G5 units. And with the computers priced more competitively than in the past, he's expecting margins of only around 26% to 28% -- well below the robust 35% range Apple's seen in the past.

That's a key point, because Cihra estimates that every 1% point swing in PowerMac gross margins is worth nearly a penny in quarterly earnings per share. Given the run-up in the stock price, he's staying neutral on the shares.

Although he's wary of the stock, even Cihra says iPod sales have impressed. At MacWorld earlier this month, Apple said it sold 730,000 units in the December quarter, far above Fulcrum's expectations for a half-million units.

The news prompted Cihra to raise his December-quarter sales outlook above the consensus estimate. He expects Apple to post $1.98 billion in sales and 16 cents in earnings.

Granted, iPods still are a relatively small part of Apple's overall business compared to computers, which contribute around 70% of sales. Even if combined sales from iPods and iTunes can grow 50% in fiscal year 2004, music will account for only 9% of Apple's revenue.

Perhaps more important, the digital music players have re-established Apple's claims to hipness. As proof of the company's drawing power, fund manager Kaiser points to the decision to price its

just-introduced iPod Mini -- supposed to be the low end of its iPod line -- at a healthy $249. "That's a very blatant statement saying we have a better product," Kaiser said. "If it were a price decision, they would have set it at $149."

iPods just may prove to be the key for Apple to push into new markets, too. Last week, the company startled market-watchers by announcing it will start supplying iPods to Hewlett-Packard, which will resell them under its own brand. Not only does the pact mark a defeat for


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, which has been gearing up its own music venture, but it could augur more licensing deals for Apple.

For a company with only a 2% foothold in the PC market, that says volumes about the lure of Apple's technology.