Stock Watch

Apple Computer: More than iPod

There's no question that Apple Computer (AAPL) -- whose stock has tripled from this time a year ago -- has benefited from the enormous popularity of its iPod digital music system. But there is plenty of disagreement over how long the company can ride the digital music player wave.

A report in Monday's The Wall Street Journal pointed to looming competition from cell phone makers and carriers, who are "piling into mobile music with an array of new services and phones that could radically change a game that until now has been defined largely by Apple."

Gene Munster, who covers Apple for the investment firm Piper Jaffray, says that he doesn't see competition from cell phones as a real problem. "The core use of MP3 players hasn't even begun," he says, and the market isn't anywhere near saturated. Plus, he adds, "people want devices that are really good at doing one thing. I don't see it as an issue."

Although Munster says the iPod is a "critical piece" to the Apple story, he's keeping his eye on the big picture -- specifically, whether Apple is capitalizing on the iPod to grow its computer business. He thinks it is, and says he expects the iPod "to be a foundation for growth in other parts of Apple's business." Although the extent of the iPod's "halo effect" is controversial, he says, "we clearly believe that as people experience Apple products they're more likely to buy an Apple computer for the first time."

Banc of America analyst Keith Bachman, who rates the stock a "buy," likes the long-term fundamentals of Apple. In a research note issued last month, he says that he sees plenty of opportunity for Apple to increase sales of its computers -- particularly the Mac mini -- by expanding distribution to stores such as Best Buy, Circuit City and Comp USA. He figures that the company currently sells fewer than 5% of its desktops and notebooks at these stores.

Apple is scheduled to release its fiscal second-quarter earnings report on Wednesday evening. Munster reiterated his "outperform" rating for the stock on Monday in anticipation of the report. He expects the company to edge past Wall Street's estimates, based on what he sees as solid demand for key products, such as the iMac, Powerbook, Mac mini and iPod systems. He notes that the Power Mac saw weak sales, however, and supply for the iPod shuffle was inconsistent.

He expects the company to issue a better-than-expected forecast for the third quarter.

JP Morgan analyst Bill Shope also reiterated his positive rating on the stock on Monday and bumped up his earnings estimates slightly for the quarter and for the year. He says that the stock will likely rise following the report, "as the company's share gains across its product lines and accelerating operating leverage [from the digital music business in particular] becomes increasingly apparent."

Shares fell more than 4% on Monday, to $42. The stock sells for about 36 times the consensus earnings estimate of $1.17 for calendar 2005, according to Thomson First Call (compared with a P/E of about 16 for Standard & Poor's 500-stock index). Munster thinks shares will reach $50 over the next 12 months.

--Lisa Dixon

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