Oil and Keeping the Green Revolution Turning

OIL (All historic prices cited are indexed to inflation)
Pretty much everyone I saw in person in the late spring and summer heard me very enthusiastically telling everyone who would listen (and many I am sure wished I would shut up after hearing it several times) about the upcoming crash in Oil. I clearly remember the disbelieving looks and sneers when I told some individuals that I believed Oil would be at $50 per barrel within 5 years. I didn't think that it would happen quite this fast, but I knew it would. I posted a short note on this blog on Friday, June 13th, 2008, and I shared my unfinished in-depth entry with a few friends who were interested. I do want to put it up eventually as I still find the logic behind it interesting.

Right now I still see some room for oil to continue down. Demand destruction has not let up. I believe that we may return to the average price that oil has been at over the last 60 years which is right around $25 in current inflation indexed dollars. After the last energy crisis when oil peaked in 1981 to the mid $70's in today's dollars, it fell back to the $20's by 1985 where it stayed until 1998 (with the exception of the quick spike to $50 due to the first gulf war.

In the very near term, we will probably see some spikes especially with OPEC threatening that it will cut production at its next meeting on December 17th. I believe that they will probably be aggressive and cut quotas in the 2-3 million barrel per day range. OPEC has traditionally had a hard time enforcing their quotas and I believe that demand destruction will continue and outstrip the decrease in production. I would not be surprised at all if demand in the US fell to the 15 to 17 million barrel per day range.

I do feel like the easy money on the downside of oil has already been made, and I would not recommend that anyone without significant experience trade this market to the downside. I bought $80 USO (United States Oil fund ETF) puts when crude was trading around $130 per barrel. I have closed all those positions out except for one with a January 2010 expiration date which I am watching very closely.

We are finally in a relatively good place when it comes to oil. I actually think output cuts are a good thing for the overall balance of the market. We won't be strained against hard production limits and if demand does pick up, more production can be brought online relatively quickly and easily which means we should be safe from crisis conditions for awhile. Having prices kept a little higher than those that would occur with no cuts is also a positive because it encourages continued conservation and investment and adoption of alternative energy technologies.

ONLY YOU CAN PREVENT HIGH OIL PRICES!!
Here's the thing. During the massive run up in oil prices I felt that there was a lot of misguided anger toward all sorts of entities, especially oil companies (whose actual profit margins did not increase by very much at all). While I feel that speculation was one of the biggest causes of the insane runup and subsequent bubble, the other big cause is the oil consumer and the fact that oil was so cheap for so long which discouraged investment, development, and adoption of alernative energy sources.

I am happy with the many steps that Americans and citizens of many parts of the world have taken to become 'greener' such as increasing conservation and the investment in and use of new practices and technologies which are more sustainable and eco-friendly. The key is that we as a society must continue along this path for environmental reasons and for economic ones.

Each one of us has a choice and we each must continue to do our part, as a people, we cannot go back to being wasteful as that will put us right back into a crisis situation. Americans use twice as much oil per person as citizens in most developed European countries. We must continue to reduce our dependence on oil even if it stays cheap as only then will renewable energy realize the economies of scale which will bring the price of alternative energy down. So keep the smaller car, keep taking the train or carpooling, continue to replace your light bulbs with florescents and to cut energy consumption in other ways and continue to invest in and support companies who make an effort to be 'green' and who develop alternative energy technologies.

If you choose not to, I will be ready with a mirror for the next time you complain about how the 'greedy oil companies' are 'making' the price of gas high.

Panicky Investors: "OMG! Apple is teh DOOMED!"

It may just be another great opportunity to pick up some AAPL.

Apple just reported their 2008 third fiscal quarter results. Overall it was another insanely great quarter. This was the best June quarter for Apple in terms of both revenue and earnings, and represents the best quarter of all time for Mac sales. Revenues were up 38 percent to $7.46 billion and profits were up 31% to $1.07 billion or $1.19 per share. The analyst consensus estimates were for earnings of $1.08 per share which Apple handily beat by 10%. Sales in Apple's own retail stores increased 58%. Apple added $1.33 billion to their cash position to end the quarter with $20.8 billion in cash and no debt.

Apple shipped 2,496,000 Macintosh computers in the June quarter for an increase of 41% over the year ago quarter. Apple has been able to significanly increase unit sales, revenues, and market share for its lucrative and high margin computer business due to a combination of factors including the huge amount of user dissatisfaction with Windows Vista, the 'halo' effect from their other products, and gaining acceptance of MacOS as an operating system. The Gartner group now ranks Apple as the number three US PC vendor with 8.5 percent market share. Not only did Apple increase sales by the largest percentage of the major manufacturers, they also increased sales by more units than HP. With only 8.5% market share, Apple has significant room to grow in this area. I believe that a good deal of Apple's growth both in revenues and profits going forward will come from Macintosh sales.

Apple sold 11,011,000 iPods this quarter which represents unit growth of 12% and revenue growth of seven percent. The average selling price of iPods has been declining due to the sales of a much larger amount of inexpensive shuffles, especially after a recent price cut. Due to the already high market share Apple enjoys in the MP3 player business (as high as 70% in some countries), I do not see this area of business as a significant growth driver. I believe that iPod sales will show some growth, but will eventually start trending toward being flat especially due to decreased demand for iPods from owners of iPhones.

There are quite a few accounting items which actually make iPhone sales, revenue, and earnings seem lower than they are. Apple shipped 717,000 first generation iPhones during the June quarter. This number is significant because of the fact that in early May the stock of the first generation was pretty well sold out and not replaced due to the pending release of the 3G model. Therefore, no iPhones could be sold for more than half the quarter. Also, the revenue for all first generation iPhones sold after March 6th (the date the 2.0 software was announced) was booked on July 11th when the 2.0 software and the 3G iPhone was released. Therefore, all iPhone revenue and earnings in the June quarter is for iPhones sold prior to March 6th. Additionally, due to accounting rules, since Apple is making new features and software available for the iPhones available at no additional cost, they account for the revenues and earnings on a subscription based model over 24 months. Therefore, an iPhone sold in a particular quarter would only add 12.5% of its total revenue and earnings to that quarter's results.

Response to the iPhone 3G was described by Apple management as "stunning." The phone sold one million units within 3 days of release. This is contrasted to the 74 days it took to sell the first million original iPhones or the nearly two years to sell the first million iPods. I personally wouldn't be surprised if Apple sells 10 million of the iPhone 3G before the end of calendar year 2008. Apple is currently having trouble keeping up with the incredible amount of demand for the new phone, but they say their production ramp is going well. Apple will launch the iPhone 3G in an additional 20 countries on August 22nd bringing the total to over 40, and plans on having it available in more than 70 countries before the end of 2008. The App store is also doing extremely well, and adds significantly to the value of the iPhone and iPod Touch. There are currently over 900 applications available from the App store and users have already completed over 25 million downloads of programs. Apple recieves 30% of all revenue from application sales, while the remaining 70% is passed on to the developers. The iPhone currently enjoys a 28% share of the smartphone market which leaves plenty of room for growth, especially as the smartphone market grows to a larger percentage of the cell phone market as a whole.

There was some talk in the call about a "product transition" which will lower gross margins to the 30 percent level for the 2009 fiscal year. The explanation that Peter Oppenheimer gave for this is that Apple is

"delivering state-of-the-art products at price points that our competitors can’t match, which has resulted in market share gains in each of our products. We plan to continue this strategy and to deliver great value to our customers while making a reasonable margin but not a margin so high as to leave an umbrella for our competitors.

In addition, and one of the investments that we make is to introduce new products that initially cost more because they deliver an entirely new level of value to the customer. Then we ride the cost curves down with value engineering and volume manufacturing, leaving us far ahead of our competitors."

While I won't speculate on what the product introduction will be, I believe that the temporarilary lower margins will be well worth it due to higher overall profits and market share. From management's comments on the call, it definitely seemed that this new product transition will be released in the current quarter ending in September. This release, depending on how it is received could easily push the stock well over $200 per share.

The only thing in the whole conference call which gave me some pause were the concerns about Steve Jobs' health. Apple had previously stated that he is on antibiotics for a 'common bug'. Today in the call, management stated that Steve loves Apple and has no plans on leaving and that his health is a "private matter." On a deeply personal level, I wish Steve the best of health. As one of the people I look up to most, his genius in so many fields is unequalled and his innovative vision is unsurpassed. The world would be a much less interesting place if it were not for Steve's many contributions. He truly did put a dent in the universe, and I am sure he is not done yet.

Apple is currently down about 10% to under $150 in the after-hours trading on this great quarter's results. I view this as a good buying opportunity for long term investors especially if we see some good pullbacks. I believe that the institutions, funds, etc are going to use this as an opportunity to get in before it really runs up. I am reiterating my price target of $200 before the end of January, 2009 which I made in my blog post AAPL's on sale... when Apple was trading at 135.60. I really don't know what more you would want than a company growing profits by over 30% in this market environment which is best in class, with tons of innovative products, no debt, and nearly $21 billion in cash. Even if hard times are ahead, this is a company that has the resources to weather the storm. Apple's future looks very bright to me and I will be holding tight through this short term volatility.

Full Disclosure: I have been long AAPL continuously since August 4th, 2004.

Apple Reports Record Third Quarter Results

Revenue Up 38 Percent Year-Over-Year
Mac Sales Reach All-Time High

CUPERTINO, California—July 21, 2008—Apple® today announced financial results for its fiscal 2008 third quarter ended June 28, 2008. The Company posted revenue of $7.46 billion and net quarterly profit of $1.07 billion, or $1.19 per diluted share. These results compare to revenue of $5.41 billion and net quarterly profit of $818 million, or $.92 per diluted share, in the year-ago quarter. Gross margin was 34.8 percent, down from 36.9 percent in the year-ago quarter. International sales accounted for 42 percent of the quarter’s revenue.

Apple shipped 2,496,000 Macintosh® computers during the quarter, representing 41 percent unit growth and 43 percent revenue growth over the year-ago quarter. The Company sold 11,011,000 iPods during the quarter, representing 12 percent unit growth and seven percent revenue growth over the year-ago quarter. Quarterly iPhone™ units sold were 717,000 compared to 270,000 in the year-ago-quarter.

“We’re proud to report the best June quarter for both revenue and earnings in Apple’s history,” said Steve Jobs, Apple’s CEO. “We set a new record for Mac sales, we think we have a real winner with our new iPhone 3G, and we’re busy finishing several more wonderful new products to launch in the coming months.”

“We’re extremely pleased with the growth of our business and the generation of almost $5.4 billion in cash in the first three quarters of fiscal 2008,” said Peter Oppenheimer, Apple’s CFO. “Looking ahead to the fourth quarter of fiscal 2008, we expect revenue of about $7.8 billion and earnings per diluted share of about $1.00.”

Panicky Investors: "OMG! Google is teh DOOMED!"

Wow, so Google was only able to increase profits by 35% and revenue by 39% in an extremely challenging economic environment. Seriously, most companies would kill for this type of growth during the best of times and Google is producing it during a slowdown and in a seasonally weak period for search. The 3.2 billion dollar purchase of DoubleClick (which significantly lowered their cash position) and the decline in interest rates also reduced the return on their cash position.

It is also not like they are sitting around doing nothing about it, they are watching their budget more closely, are holding expenses down relative to revenue and have slowed their rate of hiring. I see the slowdown in hiring as a positive, but for some reason, many in the financial press are bemoaning this as a negative. One of the major challenges that companies like Google and Apple have face in hiring is finding enough qualified people. I would be more alarmed if they ignored the economic realities and continued hiring and spending at their previous rate. I see Google as the type of company where having too many employees will run up expenses without significantly increasing profits. I believe that Google is currently well staffed for its current initiatives and does not need to significantly increase headcount to achieve its goals. In tech R&D quality is a lot more important than quantity both in terms of dollars and staff. Look at Apple vs. Microsoft as a good example. Microsoft outspends and outstaffs Apple several times over, but Apple continually produces better and more innovative products. Controlling spending and cutting waste is always a good thing in my book, and a slowdown can be just the thing to force a prioritization in spending which will increase efficiency and ensure the future good health of a company.

The other important point to consider is that Google is maturing and already controls a huge portion of the market, they handle 69% of all search queries and bring in over 77% of all search advertising revenue. They simply will not be able to continue their previous levels of growth forever. While they are rapidly moving into new territory and I trust Google to innovate and find new opportunities better than 99% of the companies out there, it is simply impossible to grow profits which are over a billion dollars per quarter as fast as when they were in the millions.

I would recommend keeping a close watch on this stock this quarter. If it pulls back significantly due to panic selling related to this earnings disappointment, it could represent an excellent buying opportunity. Google is the undisputed leader in search and one of the most innovative companies around. I am routinely amazed by the products they release which are often exponentially better than those of their competitors (even if they remain in beta forever :).

Full Disclosure: I have been long GOOG continuously since August 19th, 2004

Google 2Q letdown raises economic worries (Excerpts from AP Story featured on Yahoo!)
SAN FRANCISCO (AP) -- Google Inc.'s earnings growth bogged down more than investors anticipated during the second quarter, raising worries that the ailing U.S. economy is starting to sap the Internet search leader.

Google earned $1.25 billion, or $3.92 per share, during the three months ended in June. That represented a 35 percent increase from net income of $925 million, or $2.93 per share, at the same time last year.

If not for costs incurred for employee stock compensation, Google said it would have earned $4.63 per share. That figure missed the average earnings estimate of $4.74 per share among analysts surveyed by Thomson Financial.

It marked just the fourth time that Google hasn't exceeded analyst expectations in its 16 quarters as a public company.

Investors expressed their dismay as Google shares plummeted $40.70, or 7.6 percent, in Thursday's extended trading after closing at $533.44, down $2.16.

Google's second-quarter revenue fared slightly better than earnings, rising 39 percent to $5.37 billion from $3.87 billion at the same time last year.

Off to run the Pittsfield Peaks Ultra Challenge and Death Race

I am leaving to run the Pittsfield Peaks Ultra Challenge on Saturday, June 14th and the Pittsfield Peaks Death Race on Saturday, June 21st in Vermont.  The Ultra Challenge is a 53 mile race with 14,000' of elevation gain, and the Death Race is a 10 mile race with extremely challenging obstacles.  Each has a 24 hour time limit.  My goal for these races is simply to finish as this represents my first ultramarathon, and so far only four people have finished the death race.

Check out last year's version of the races in this YouTube Video or check out the Peak Races Web Site.

I have a lot of posts which I want to write for this blog that have been bouncing around in my head for quite some time.  I am finally starting to structure them and work them out in draft form, so I will actually start putting this blog to use.  A lot of my ideas are clear to me, but putting them into a form which is understandable and will not be misinterpreted is somewhat difficult.

I am currently working on a post called "The Green Revolution"  It is currently over 6 standard pages long and is ballooning in size as I continue to think of new points which I want to make.  Basically it is support for my theory that we will see $70-$80 per barrel oil within 2 years and $50 per barrel oil within 5 years.  I believe that the oil bubble will burst due to increased use of alternative energy, greater efficiency and conservation brought about by today’s high prices along with the fact that speculative profitability in this market is unsustainable.  I believe that the current pain we are feeling from high energy prices is engaging market forces which will result in a great deal of change that will be quite beneficial in the long run.  I wanted to get it done before leaving for Pittsfield but I just didn't have the time and didn't want to post it in an unfinished state.

AAPL’s on sale...

For anyone who has been looking for an entry point into Apple stock and has a long term time horizon (over a year, preferably quite a bit longer), now might be your best shot.

After posting an insanely great quarter, the stock fell to below $140 per share from a high just a few weeks ago of over $200. Yes, their guidance going forward shows slower growth, but they are always very reserved when discussing the future. I can't remember a time in the last 5 years when they did not beat their internal guidance.

The key is that there is nothing fundamentally wrong with this company. The decline is momentum panic selling. I have full confidence that it will recover to over the $200 level within 12 months as long as there is no meltdown of the entire economy. I would still rather be in this stock than pretty much any other. Steve Jobs is still in charge of course and he is one of the most visionary people in any industry.

"For its fiscal first-quarter, Apple earned $1.58 billion, or $1.76 a share, on revenue of $9.6 billion. During the same period a year ago, Apple earned $1 billion, or $1.14 a share, on $7.12 billion in sales. In a statement, Apple Chief Executive Steve Jobs said that the results showed the company posting its highest quarterly earnings and sales in history." -CBS Marketwatch Article

Full disclosure:
I personally am not buying at this point in time as AAPL already makes up about 15% of my total net worth and it is generally not recommended to go over 10% in a single stock.