Merrill Lynch Bearish On Apple; Recommends Intel Switch

by , 9:00 AM EDT, April 10th, 2003

Saying Apple's primary markets will continue to be weak for some time to come, investment firm Merrill Lynch is telling its customers Apple stock is too expensive and they should continue to stay away from owning it. In addition, Merrill Lynch suggested Apple might fare better if it seriously considered switching from the PowerPC processor to Intel or AMD processors as "a positive driver for the stock."

In a comment report to clients, Merrill Lynch analyst Michael Hillmeyer said that while Apple's fiscal second-quarter results will be roughly in-line with what the company predicted in January, the stocks volatility is still high and investors should shy away from buying Apple, or sell the stock if they presently hold it. "We maintain...that the stock remains expensive on price-to-earnings and price-to-share ratios," Hillmeyer wrote. "In addition, we think that potential reports of weakness in Apple's primary markets (consumer, education, design professionals) over the next few months could also negatively impact the stock."

Hillmeyer is maintaining a conservative outlook on Apple for revenue of US$1.43 billion - down 3.2% quarter-to-quarter - and earnings per share of one cent. The consensus among analyst is two cents for the March quarter. Hillmeyer cautioned that it is possible that sales of G4 PowerBooks could result in revenue closer to the street consensus of $1.46 billion.

As for its stock price, Hillmeyer believes Apple could trade at or even below $11.50 a share over the next year, "especially if Apple continues to run an operating loss while losing market share." At present, Apple's net cash position puts its stock price at roughly $11.50. Since December, Apple stock has traded for between $14 and $15 a share.

With state and local educational budgets strained to historic limits as a result of the weak U.S. economy and reduced tax revenues, Hillmeyer believes spending on computer systems may deteriorate further, and that could negatively affect Apple stock through the current quarter and into the summer months. He reported "particular weakness among design professionals" will also hurt Apple's position.

Laying praise on Apple's "top-notch" products and well executed management strategy, Hillmeyer said another issue of concern is Apple's relatively higher prices that it must charge for products because of their proprietary nature. "(That) will likely lead to continued shares losses for the company, at least until the environment improves," he wrote. Improvement could come towards the end of 2004, Hillmeyer envisions.

In a critical light, Hillmeyer suggested Apple should seriously consider switching to a more "industry standard" processor like those from Intel or AMD, and move away from the PowerPC processor if it wants to improve its long-term competitiveness. "The engineering of systems around non-standard processors (PowerPC) that are both more expensive and slower (by many measures) than the industry standard adds to operating expenses and may not be a sustainable strategy, in our opinion...a decision to use Intel or AMD processors...could be a positive driver for the stock if management were to make the switch."

Interestingly, the Merrill Lynch report had no comment on Apple's retail store strategy, which has yet to post a profit.

Hillmeyer's estimates iMac unit sales will be off 2.7% in the March quarter compared to the same quarter last year. Breaking out other product groups, he believes iBook sales will be off 3.2%, PowerMac sales off 8.2% and PowerBook sales off 8.9%. Total PC units will be off 2.4%, Merrill Lynch estimates.

In terms of what will sell best, Merrill Lynch along with Apple guidance estimates iMac units will make up 40% of all unit sales, followed by 24.8% for iBooks, 20% for PowerMacs, and 15.2% for PowerBooks.

On a lighter note, Hillmeyer ended the analysis by reporting Apple's announcement of former Vice President Al Gore's appointment to the company's board of directors. "There is no truth to the rumor that President Bush has demanded a recount," he wrote.

Apple reports March quarterly earnings on Wednesday, April 16 at 5pm EST.