Analyst sees quantitative proof of the iPod halo effect

In a research note released to clients on Thursday and obtained by AppleInsider, analyst Steve Milunovich said Apple beat his firm's "best-case scenario" but only with the help of unsustainable margin expansion. "We figured Apple could report up to $0.30 best case yet it hit $0.34. There was 6-7 cents of unlikely-to-recur margin benefit in a high gross margin and depressed R&D."

The analyst said the iPod is bringing new users to the Apple family, which is benefiting not only Mac sales but also peripherals and software. He believes the next change in perception could be that Apple is building a sustainable consumer franchise.

"iPod and now Mac success has been underestimated by the market," Milunovich said. "Now investors need to stand back and consider whether Apple has created a pattern of introducing creative products to a consumer hungry for easy-to-use technology."

Going forward, Merrill Lynch believes Apple is likely to beat guidance, but not by much. With supply of Apple's hottest products now in sync with demand and the gross margin likely to decline sequentially, the firm says June guidance of 28 cents per share is "more realistic." Still, Milunovich said some upside is visible and raised his fiscal year 2005 estimates from $1.05 to $1.30 and 2006 estimates from $1.30 to $1.55.

Merrill Lynch reiterated a 'Buy' rating on Apple with a price objective of $51 per share. The firm noted that Apple stock broke its 50-day moving average, which could cause short-term underperformance.

"But in a growth sector lacking growth, we think investors will be attracted to Apple," Milunovich said. "Valuation is attractive, in our view, with the stock at 27X our new F2006 estimate."

Apple stock this afternoon was down 7.5% or $3.08 on extremely heavy volume.