Analyst confident in Apple strategy, predicts 1GB nano

Noting that Apple's shares have fallen 17 percent from recent highs, the firm this week attempted to address some investor concerns that appear to be causing volatility in the stock, including: slower Mac sales in light of the Intel transition, concerns about sequential declines in iPod nano sales and recent negative news stories including speculation about potential competitive offerings from Google and Microsoft.

"While we believe there are some near-term risks to earnings upside due to the transition to Intel processors in the first half calendar 2006, we believe several fundamental positives position Apple for continued growth and share price appreciation over the long-term," analyst Ben Reitzes wrote in a research note on Monday. "We are still confident in Apple's product road map – including potential for new iBooks by April in time for the June quarter, a potential "media hub" product (and more services), new iPods into year-end (including a new media player) and even a new cell phone within a year."

Intel Macs

Homing in on Intel Macs, the analyst said checks indicate sales of Apple's new iMacs with Intel processors are relatively solid with consumers, but off to a slower start with professionals and "prosumers" who are waiting for more applications to be ready in March and into mid year.

"In our surveys of Apple retail stores as well as other channels across the country, we have detected that even store representatives are encouraging customers 'to wait' more than we anticipated which has been a modest surprise," Reitzes wrote. According to the analyst's checks, creative professionals are delaying purchases due to the fact that some high-end Mac based applications are not ready for the Intel chips and applications from Adobe and Microsoft are not ready with universal binaries.

"Given the possibility for more sales to be pushed into March and the June quarter when all of Apple professional applications like Final Cut Pro, Aperture and others are available, we are cutting our Mac estimates modestly for the first half of calendar 2006," Reitzes wrote. UBS is now forecasting Mac unit sales of 979,000 this quarter versions its previous 1,128,000 estimate, including 294,000 shipments of iMacs. For the 2006 fiscal year, the firm has decreased its Mac unit sale forecast from 5,216,000 to 4,718,000. "We still expect significant Mac growth long-term with 29 percent unit growth forecast for fiscal year 2007," the firm said.

Meanwhile, the firm's survey of Apple retail stores showed a very positive reaction to the MacBook Pro in terms of pent-up demand that could be realized later this year. "Our surveys reveal the level of inquiries regarding the new MacBooks is extremely high, and it is clear that with more models and more applications, Mac sales can benefit," Reitzes wrote. "As a result, we believe any slowdown in Mac shipments is only a matter of timing over the next 2-5 months and our checks showed that solid demand exists for these products."

iPods

Reitzes also commented on what appear to be recent cuts in Apple's iPod nano orders within the supply chain. "Our latest checks do pick some modest loosening of demand in NAND flash within the supply chain that could indicate a slightly more seasonal impact than our very optimistic expectations from only a few weeks ago," he said. However, the analyst believes demand on balance is still very solid and his firm's iPod estimates remain above consensus. For the current quarter, Reitzes now estimate that Apple will ship 10 million iPods verses his previous estimate of 11.3 million. However, the analyst raised his average selling price (ASP) iPod estimates to $226 from $210, due to strong sales of higher priced iPods such as the 30GB and 60GB video iPods.

The analyst also predicts Apple to sell as many as 1 million iPod Radio accessories and says the company appears to be "getting set to 'end of life' the [iPod] shuffle possibly in favor of a 1GB version of the nano."

Competition from Google and Microsoft

Downplaying concerns over potential competition from Microsoft in the MP3 player market, Reiztes said he does not view an MP3 device from Microsoft as necessarily a huge threat at this time, given Apple's head start, leading design and compelling iTunes software. Similarly, the analyst said that even if Google were to eventually launch a competing music service, he believe Apple's partnership with content providers as well as the user friendly design of its iTunes software should continue to drive leading sales of music and video content through its music store.

"We continue to believe that Apple has the best 'mouse trap' — not just the best media player, but also the best delivery system (iTunes), the best content partnerships (Disney, NBC, etc.), and most importantly the easiest and simplest access format," Reitzes wrote. "We continue to believe Apple is the best positioned to capture growth from digital content trends."

Long Term Positives

Turning to potential positives, the analyst expects iPod accessories, iTunes Gift Cards, and new products to help to drive revenues during the current quarter. Specifically, Reiztes notes that Apple is completely sold out of its iPod Radio accessory, which has been extremely popular with consumers. He also notes that revenue generated from iTunes Gift Cards sold during the holiday season were booked as "deferred revenue" in the company's first quarter of the year. Sales of the cards could boost Apple's "Other Music Products" category this quarter as consumers redeem purchased songs. Reitzes also believes Apple's innovation could deliver exciting new products such as a DVR-capable Mac and Apple-branded cell phone sometime in 2006.

Adjusting Near-term Estimates

"While our estimates remain above consensus, we are cutting our second quarter earnings-per-share (EPS) estimate to 46 cents (was 50 cents) on revenues of $4.7B reflecting modestly lower Mac estimates and a quart-to-quarter decline in iPod sales," Reitzes wrote. "Our fiscal year (FY) 2006 EPS estimate is now $2.14 (was $2.24) on revenue of $20.5B (was $21.5B) but our FY07 EPS estimate remains $2.75."

The analyst added, "Our checks back some Mac concerns, but we regard the transition as a timing issue."

UBS Investment Research maintains a "Buy" rating on Apple with a price target of $100.