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					North America Equity Research
17 July 2009

Apple Inc.
F3Q09 Preview: Raising Estimates on Mac Surge; Lifting Price Target to $167.50
We recommend building or adding positions in Overweight-rated Apple. We are raising our operating estimates, and the flow-through effects lift our Dec-09 price target to $167.50, versus $155.00 previously. The earnings revisions are top-line driven, as gross margins could lack major upward mobility due to less favorable component pricing. Inputs from primary research contacts indicate a Mac surge in the second half of the June quarter. While partly explained by the early June MacBook refresh, we believe sturdier demand also helped. We also are increasing our iPhone estimates, but iPod numbers are coming down. • We expect a strong showing from Apple in the June quarter. Apple is set to report results on Tuesday, July 22. We are lifting our EPS estimates above the Street consensus. Our revised revenue and EPS estimates are $8.497 billion and $1.23, versus $8.114 billion and $1.12 previously. Consensus is at $8.214 billion and $1.16. • Mac surge bigger than expected. Inputs from primary research contacts suggest a surge in Macs, particularly notebooks, in the second half of the June quarter. We are lifting our unit estimates for the total Mac business to 2.50M, versus 2.13M previously. We think investors’ expectations are between 2.3-2.4M units. If reported results confirm such upside, then we expect investor sentiment to reset higher. • iPhone builds continue to rise following 3GS release. Our conversations with industry contacts suggest the build activity in the supply chain related to the iPhone continues to rise. We think this dynamic suggests continued momentum, as typically the build activity eases following initial product launch. As a result, for the June quarter, we are raising our iPhone unit estimates to 4.34M, versus 3.88M previously. • iPod stands to be lighter, but we think the stock already has adjusted. We expect the iPod touch to remain Apple’s quasi-netbook stub. We continue to believe that the device offers enough features to partially take advantage of increasing customer adoption of netbooks. Despite this view, we are concerned that the traditional iPods could exhibit lighter volumes. Our conversations from industry contacts have been mixed, with a tilt to the downside.

Overweight
AAPL, AAPL US Price: $147.52

▲ Price Target: $167.50
Previous: $155.00

IT Hardware and Imaging Mark Moskowitz
AC

(1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

Anthony Luscri
(1-415) 315-6702 anthony.s.luscri@jpmorgan.com J.P. Morgan Securities Inc.
Price Performance
180 140 $ 100 60
Jul-08 Oct-08 Jan-09 Apr-09 Jul-09

YTD Abs 72.1%

1m 7.9%

3m 24.9%

12m -13.4%

Apple Inc. (AAPL;AAPL US) 2008A EPS Reported ($) Q1 (Dec) Q2 (Mar) Q3 (Jun) Q4 (Sep) FY CY Revenues FY ($ mn) 1.76 1.16 1.19 1.26 5.36 5.38 32,479 2009E
(Old)

2009E
(New)

2010E
(Old)

2010E
(New)

1.78A 1.33A 1.12A 1.27A 5.51A 5.42A 35,261A

1.78A 1.33A 1.23A 1.34A 5.68A 5.68A 35,938A

1.70 1.46 1.51 1.53 6.20 6.47 40,401

1.79 1.52 1.57 1.62 6.50 6.80 41,002

Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ bn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date

147.52 16 Jul 09 180.45 - 78.20 131.47 Sep 891 167.50 31 Dec 09

Source: Company data, Reuters, J.P. Morgan estimates. Note: above EPS figures include FAS123R expenses.

See page 8 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Customers of J.P. Morgan in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.

Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

Overview
We recommend building or adding positions in Overweight-rated Apple. We are raising our operating estimates, and the flow-through effects lift our Dec-09 price target to $167.50, versus $155.00 previously. The earnings revisions are top-line driven, as gross margins could lack major upward mobility due to less favorable component pricing. Inputs from primary research contacts indicate a Mac surge in the second half of the June quarter. While partly explained by the early June MacBook refresh, we believe sturdier demand also helped. We also are increasing our iPhone estimates, but iPod numbers are coming down.

Key Points
We believe Apple offers suitable levers to sidestep a mini-stock correction In our June 24 industry report entitled “The Quarterly Crossroads,” we suggested that a mini-stock correction was in the making as relates to technology stocks. We think stocks are tuned for numbers to move above consensus EPS estimates, which could be difficult as the global downturn rolls on. We believe stocks that are able to raise numbers stand to sidestep any downward pressure in valuations, and here, we highlight Apple. Our end of quarter checks with industry contacts suggest that Apple’s business volumes should exceed investors’ expectations. We believe the upside potential is driven by both the Mac and iPhone businesses, and these factors should keep the stock pointing upward. We expect a strong showing from Apple in the June quarter Apple is set to report June quarter results on Tuesday, July 22. We are lifting our EPS estimates above the Street consensus. Our revised revenue and EPS estimates are $8.497 billion and $1.23, versus $8.114 billion and $1.12 previously. Consensus is at $8.214 billion and $1.16. Our revised gross and operating margin estimates are 34.4% and 18.1%, versus 33.8% and 17.5% previously.
Table 1: J.P. Morgan Estimates for June and September Quarters versus the Street Consensus
$ in millions, except per share; units in 000s June Quarter J.P. Morgan Consensus $8,497 $8,214 876 1,624 2,500 10,274 4,335 34.4% 18.1% $1.23 $1.16 September Quarter J.P. Morgan Consensus $9,111 $9,051 909 1,765 2,674 10,663 5,614 34.5% 18.4% $1.34 $1.28

Revenues Units Desktops Notebooks Total Macs iPod iPhone Gross margin Operating margin EPS

Source: Company reports, Capital IQ, and J.P. Morgan estimates.

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

Mac surge bigger than expected Inputs from primary research contacts suggest a surge in Macs, particularly notebooks, in the second half of the quarter. We are lifting our unit estimates for the total Mac business to 2.50 million, versus 2.13 million previously. We think investors’ expectations are between 2.3-2.4 million units. If reported results confirm such upside, then we expect investor sentiment to reset higher. While the channel fill related to the MacBook refresh in early June helped, end demand also was sturdier than expected. Meanwhile, desktops fared better as a result of discounting in the education vertical. So, despite our unit increases, we do incorporate incremental ASP erosion. iPhone builds continue to rise following 3GS release Our conversations with industry contacts suggest that the build activity in the supply chain related to the iPhone continues to rise. We think this dynamic suggests continued momentum. Typically, the build activity should ease following initial product launch. As a result, for the June quarter, we are raising our iPhone unit estimates to 4.34 million, versus 3.88 million previously. In our view, investors’ expectations are for units to be around 4.0 million, which means there is not much controversy with our revision. iPod stands to be lighter, but we think the stock already has adjusted We expect the iPod touch to remain Apple’s quasi-netbook stub. We continue to believe that the device offers enough features to partially take advantage of increasing customer adoption of netbooks in PCs. Despite this view, we are concerned that the traditional iPods could exhibit lighter volumes. Our conversations from industry contacts have been mixed, with a tilt to the downside. Our revised iPod unit estimate is 10.27 million, versus 10.52 million previously. Less favorable component costs and discounting limit margin upside We believe that the earnings upside at Apple should come from the top-line expansion. General industry commentary suggests that component costs have not been as favorable. We had previewed this concern ahead of Dell’s analyst meeting, and Dell confirmed as much with its disappointing intra-quarter update on Monday. Another challenge to Apple’s margin profile could be the discounting in the education vertical. While discounting has moved Mac volumes, we think the lower ASPs will limit major margin expansion. The balance of these factors keeps us from lifting our gross margin assumption closer to the prior quarter’s 36.4% (March). For the June quarter, our revised estimate is 34.4%, versus 33.8% previously.

Other Topics to Consider
Below, we highlight select topics related to Apple and its operating model. This list is not intended to be exhaustive. Recall, we discussed these topics in our industry report entitled “The Quarterly Crossroads” published on June 24. In that report, we discussed macro, secular, and company-specific factors that could impact the stocks this earnings season. We highlighted Apple as one of only five stocks within our 17 stock coverage list that possesses upside potential to consensus EPS estimates. Overall, we still are expecting a mini-stock correction across the technology sector in general, but we believe that Apple offers company-specific factors that should provide suitable offsets.

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

• Will the refreshed MacBooks partially sidestep the global downturn? The recent feature set improvements and price cuts could help in certain segments. With Apple, the company's market share is still small on a global basis, so share gains in various parts of the market can still add up to be meaningful to the model. Our read on the June quarter was bigger than expected, and we think the trend-line, if confirmed in the results next week, suggests that demand helped out and not just channel fill related to the MacBook refresh. • How much impact will the new iPhone 3GS have on unit trends later this year? We think the new features should be enough enticement for new and prior generation customers to purchase the device. Our conversations with industry contacts continue to suggest that build activity related to the iPhone is rising across the food chain, which we think suggests incremental momentum. Typically, the builds ease following the initial product release date. • Can the iPod touch remain a quasi-netbook device for Apple, taking advantage of the netbook hype? We think the iPod touch provides the portability, Internet browsing, and email features that are the hallmark of the netbook PC experience. With the iPod touch, the main limitation is the small screen size relative to netbooks. While we continue to believe that Apple will introduce its own netbook-like device, in the interim, the iPod touch should help the company benefit from the latest computing trend related to the netbook. • How much investment will be required to upgrade the 100 or so Apple Retail stores? We conservatively estimate that the store upgrades could total approximately $250 million, or $2.5 million per store, and we think the investment should be more than offset. We expect the potential buzz around the remodeled stores to drive increases in customer traffic. • How long before the opening of multiple Apple stores in certain regions internationally achieve the sales synergies exhibited in the U.S. in recent years? We think this dynamic is a multi-year phenomenon that sets up Apple as a core holding for long-term investors. Provided Apple does not scale back its international store expansion plans, we expect to hear about “multiple-store regions” being established in Australia, Germany, France, and the U.K. later this year.

Earnings Outlook
For the June quarter, our revised revenue and EPS estimates are $8.497 billion and $1.23, versus $8.114 billion and $1.12 previously. The Street consensus is at $8.214 billion and $1.16. Our revised gross and operating margin estimates are 34.4% and 18.1%, versus 33.8% and 17.5% previously.
Summary financial model presented at the end of this report.

Table 2: Apple Snapshot – Consensus vs. J.P. Morgan Estimates
$ in millions, except per share data June Qtr Consensus J.P. Morgan $8,214 $8,497 $1.16 $1.23 Sep Qtr Consensus J.P. Morgan $9,051 $9,111 $1.28 $1.34 C2009 Consensus J.P. Morgan $36,707 $35,938 $5.33 $5.68

Revenues EPS

Source: FactSet and J.P. Morgan estimates.

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

For the September quarter, our revised revenue and EPS estimates are $9.111 billion and $1.34, versus $8.817 billion and $1.27 previously. The Street consensus is at $9.051 billion and $1.28. Our revised gross and operating margin estimates are 34.5% and 18.4%, versus 34.4% and 18.3% previously. We detail our estimates for the out quarters and fiscal years 2009/2010 in the front page table and the summary financial model presented at the end of this report.

Estimates Revision Quick Summary
Table 3: New vs. Old J.P. Morgan Estimates for the June and Sept. Quarters
$ in millions, except per share; units in 000s June Quarter 2009E New Old $8,497 $8,114 876 1,624 2,500 10,274 4,335 34.4% 18.1% $1.23 787 1,344 2,131 10,515 3,876 33.8% 17.5% $1.12 September Quarter 2009E New Old $9,111 $8,817 909 1,765 2,674 10,663 5,614 34.5% 18.4% $1.34 827 1,471 2,298 10,895 4,942 34.4% 18.3% $1.27

Revenues Units Desktops Notebooks Total Macs iPod iPhone Gross margin Operating margin EPS

Source: Company reports, Capital IQ, and J.P. Morgan estimates.

Valuation, Rating and Price Target Analysis
We reiterate our Overweight rating and are lifting our Dec-09 price target to $167.50 versus $155.00 previously. Our price target is derived from a weighted blend of EV/EBITDA and P/E scenarios (see below tables) utilizing historical peak/trough multiples. The stock trades at 21.7x our revised C2010 EPS estimate, versus the peer group average of 12.1x. We expect the valuation gap to persist in Apple’s favor owing to growth opportunities related to 1) the expanded iPhone portfolio, 2) the refreshed MacBook product line, 3) longer-term sales synergies from greater international penetration with Apple stores, and 4) a potential netbook-like device.

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

Table 4: Apple Inc. P&L Scenarios
$ in millions, except per share data, C2010 Sales Y/Y growth % Operating profit % of sales Interest/other inc. (exp.) Pre-tax income Income taxes Tax rate EPS Y/Y growth % Diluted shares D&A EBITDA % of sales Worst Case $40,448 10.0% $6,067 15.0% 470 $6,537 $2,027 31.0% $4.97 -12.6% 908 $921 $6,988 17.3% Base Case $42,485 15.5% $8,487 20.0% 470 $8,957 $2,777 31.0% $6.80 19.7% 908 $921 $9,408 22.1% Best Case $45,964 25.0% $10,572 23.0% 470 $11,042 $3,423 31.0% $8.39 47.6% 908 $921 $11,492 25.0%

Source: J.P. Morgan estimates. Note: Base case represents current J.P. Morgan estimates.

Table 5: Apple Inc. EV/EBITDA
$ in millions, except per share data, C2010 EV/EBITDA multiple Implied enterprise value Net debt Implied market cap Implied stock price Probability Average stock price Worst Case 12.0x $83,856 ($39,946) $123,802 $136.27 30% $170.15 Base Case 13.0x $122,306 ($39,946) $162,253 $178.60 60% Best Case 14.0x $160,895 ($39,946) $200,841 $221.07 10%

Source: J.P. Morgan estimates. Note: Base case represents current J.P. Morgan estimates.

Table 6: Apple Inc. Forward P/E
P/E Multiple Implied stock price Probability Average stock price Worst Case 23.0x $114.20 30% $164.71 Base Case 26.0x $176.88 60% Best Case 29.0x $243.20 10%

Source: J.P. Morgan estimates. Note: Base case represents current J.P. Morgan estimates.

Table 7: Apple Inc. Blended Price Target
EV/EBITDA P/E Average stock price
Source: J.P. Morgan estimates.

Price $170.15 $164.71 $167.50

Weight 50% 50%

Risks to Our Rating and Price Target
Macroeconomic and secular conditions We assume that Apple possesses partial buffers to the macroeconomic environment and the deteriorating PC market. Should incremental weakness blunt end market
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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

demand more than expected or even slow Apple’s retail store expansion, then our view and estimates could be at risk. Competitive dynamics We assume that Apple will continue to outgrow the market in PCs, music players, and smartphones. Should competitive responses in these three segments detract from Apple’s revenue streams, then our view could be at risk to the downside. Rate of new product cycles We expect Apple to sustain its accelerated cycle of new product refreshes in the coming year. Should the company begin to slow in its technology improvements and frequency of refreshes, the company’s image for leading-edge solutions could take a hit. In such a case, we fear that investors could begin to lose interest in the story.

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.

Important Disclosures
• • • Market Maker: JPMSI makes a market in the stock of Apple Inc.. Client of the Firm: Apple Inc. is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Apple Inc.. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Apple Inc..

Apple Inc. (AAPL) Price Chart Date
318 265 212 Price($) 159 106 53 0 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 N OW OW $102 OW $104 OW $155

Rating Share Price ($)
N OW OW OW OW OW 94.95 104.08 89.16 87.71 88.84 121.51 143.85

Price Target ($)
--104.00 102.00 100.00 135.00 155.00

18-Jan-07
OW $135

15-Oct-08 14-Jan-09 06-Mar-09 23-Apr-09 09-Jun-09

OW $100

18-Dec-08 OW

Source: Reuters and J.P. Morgan; price data adjusted for stock splits and dividends. Break in coverage May 01, 1999 - Oct 18, 2001, and Sep 12, 2002 - Dec 02, 2003. This chart shows J.P. Morgan's continuing coverage of this stock; the current analyst may or may not have covered it over the entire period. J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

Coverage Universe: Mark Moskowitz: Agilent Technologies (A), Apple Inc. (AAPL), Brocade Communications (BRCD), Dell Inc. (DELL), EMC (EMC), Emulex Corp. (ELX), Hewlett-Packard (HPQ), IBM (IBM), Lexmark International (LXK), National Instruments (NATI), NetApp (NTAP), QLogic Corporation (QLGC), Seagate Technology (STX), Sun Microsystems (JAVA), Voltaire (VOLT), Western Digital (WDC), Xerox Corporation (XRX)

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Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

North America Equity Research 17 July 2009

J.P. Morgan Equity Research Ratings Distribution, as of June 30, 2009 Overweight (buy) 36% 55% 36% 77% Neutral (hold) 46% 56% 52% 72% Underweight (sell) 18% 42% 12% 60%

JPM Global Equity Research Coverage IB clients* JPMSI Equity Research Coverage IB clients*

*Percentage of investment banking clients in each rating category. For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.

Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on the front of this note or your J.P. Morgan representative. Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.

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North America Equity Research 17 July 2009

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posted:7/17/2009
language:English
pages:10