Time to Short AAPL Again?

It's almost an annual thing - short AAPL in Janary/February when they peak after holiday excitement. I did this in 2006 - bought PUTs in late January when they were in the 80s and cashed out when they slid to the 50s.

I did it again in 2007 and only broke even: the iPhone announcement really moved them up. Don't believe me? AAPL has doubled in value since the iPhone was released.

But the iPhone has not taken the world by storm. It has flopped in Europe. The Asia rollout is also undergoing some questions. I assume that the US market continues to do well, although I am not seeing the iPhone in use as much as I would expect.

But here's the thing: AAPL is actually showing signs of problems. Here are the key trends that matter:

1. Global sales - Ability to move overseas into Asia is THE issue

2. iPod slowdown - Unit sales are still growing, but at a slower rate. And that growth was really driven by lower end models

3. Semiconductor costs - The chip market is the biggest profit driver for AAPL. As costs have plummeted on flash memory, AAPL has kept prices flat. It's free profit. That gravy train will end in 3 quarters.

4. Mac sales - Continuing to grow steadily.

When you review AAPL's performance, you will notice that even with booming sales, the key ratios are falling not rising. Comparing overall fiscal year 2007 (Oct 2006~Sept 2007) to the most recent quarter:

Net profit DOWN: from 14.56% to 14.54%

Operating Margins DOWN: from 18.37% to 17.05%

Return on Assets DOWN: from 16.43% to 15.43%

Return on Equity DOWN: from 28.52% to 25.96%

AAPL trades at a whopping premium to its peers. It has a P/E of 50 vs 40 for other tech companies. Price to sales is 7+ vs 5 for tech hardware. Price to cash flow of 45 vs 35. And on, and on, and on.

Which makes sense for a growing company.

Is AAPL a growing company? As we look at year-over-year growth, keep in mind that the quarter last year was a 14 week quarter, not 13 weeks this year. Meaning that AAPL's sales and EPS would be ~7% higher.

Sales Growth most recent quarter: 25% (or 32% if comparing 14 week quarters)

Expected Sales growth for FY2008: 32% or another $7.5B.

So that's predicting a flat sales growth. Which is strange considering the explosive empahsis on iPhone sales in that quarter.

Can they churn out another $7.5B in growth?
Assume that the pressure of new business is split between existing products and the new iPhone. Let's say 20% growth from Mac and iPhones (remember iPhone growth will be single digit this year), the remaining 12% growth or $3B is iPhones. They need to sell 10M iPhones this year - and that's doable. Unless sales fizzle overseas (they have) and the US market stops sizzling (it will).

But growth in EPS is not being forecast. EPS is actually set to reverse! This is very, very interesting.
Last year sales rose 26% and EPS rose 30%
Next year, the forecast is Sales to grow 32% but EPS only 28%. When EPS grows slower than Sales, that says margins are expected to drop.

EPS Growth last quarter: 67% (or 74% adjusted for 14 week quarter)
Expected EPS growth FY2008: 28%
Yikes. Expectations about EPS growth seem to be falling.

Now think in terms of what makes a stock price sing: upside surprises and growth.
Growth is now becoming hard to come by as reflected in falling EPS growth rates and slipping margins.
Upside surprises also seem challenging. EPS surprises have fallen from 43% to 17% - and those were driven by chip costs.


And what if the US slips into a consumer recession this year? Will global growth pick up the slack?

Bottom line: at $200 per share, AAPL is trading at a forward P/E of 30, which is their expected growth. So where is the upside? I can see plenty of downside pressures, but I struggle to see upside.

I would expect them to hit $210 or even $220 over the next 3 weeks. And then it's time to short. At $160 I would get out. Right now, the July $180 Puts are $16.40 (almost a 10% cost of the underlying asset). A move to $210 would bring them closer to $13. At $220, maybe $8.

What are the odds of a big pullback? AAPL has doubled in 6 months on the back of a 10% sales growth. It needs to consolidate and drop.