Needham & Co analyst Charles Wolf has reaffirmed his 'Buy' rating on Apple stock, and predicts a price target of $27.

Wolf has reduced earnings estimates for 2004 to $0.50 from $0.55 per share, reflecting lower gross margins as Apple "changes its product mix". Despite this, the company "exceeded expectations" in the just-gone quarter.

Macworld can exclusively reveal this analysts' upbeat assessment for Apple: "The Apple story has become analogous to a rich boy, poor boy story. The company is finally growing revenues at a material rate – up 36 per cent in the first quarter and they should be up at least 20 per cent for the year." Wolf points out that margins are not rising in line with this growth, reflecting rising expenses, continued research and development spend and investment in extending the number of retail stores the company has. Apple retail has seen a "standout quarter", the analyst said.

Wolf describes Power Mac G5 sales as "in line with estimates", but adds: "Sales of the iMac were once again disappointing. Once the flagship of the product portfolio, the iMac has become something of a stepchild," Wolf writes.


Looking into the analytical crystal ball, Wolf "continues to recommend the stock" for a number of reasons:

"Apple is reinventing itself from a pure PC company into one that should be able to ride the digital revolution in the consumer electronics arena… Apple should emerge as a solid growth story moving forward."

The analyst also notes Apple's move to favour notebooks in its products, and points out that the Power Mac G5 is igniting interest within new markets: "The G5 upgrade cycle has the potential to surprise on the upside," he says.

Apple's decision to bridge the Mac-versus-Windows market with its iPod and iTunes Music Store also elicits praise from Wolf: "In our opinion, Apple's decision to port iTunes to the Windows platform was the most strategically significant one the company made since Steve Jobs' return in 1997. It signalled that Apple would no longer confine its award-winning software to the Mac but instead leverage it to address a market where 95 per cent of consumers use Windows PCs." Apple's Music Store sales tripled after the iTunes for Windows launch.

On Apple's decision to use the open standard AAC (Advanced Audio Coding) format in its store in combination with its in-house developed Fairplay digital rights management system is also noted. While this creates a "turnkey solution" that means iPod owners are locked into Apple's music store, Wolf plays down Microsoft's criticism of the move.

Music consumers 'indifferent' to MS

Noting Microsoft's past practices, which have marginalized competitors even in cases in which the competition have offered superior products, Wolf writes: "Fortunately, for Apple, the economics of increasing returns that encouraged software developers and users to support a single platform in the PC world do not apply to music stores or players. Consumers have been indifferent to the wide range of stores and players that use Microsoft's Windows Media format."

"They regard these stores and players as inherently inferior" to the Apple equivalents, he says.

Microsoft's argument that Apple's offerings would become marginalized have also been "turned on their head", Wolf believes, with the HP/Apple alliance under which HP is to produce its own variant of the iPod and will bundle Apple's iTunes software with its PCs.

"With this agreement the leading consumer PC company will be selling Apple's music offerings. HP captured 28 per cent of the US home PC market and a 17 per cent of the global home PC market in the third quarter 2003," Wolf says. Apple is also free to arrange similar deals with other manufacturers.

"Clearly HP will cannibalize some of Apple's iPod sales; but HP has 110,000 points of retail presence around the globe whereas the iPod is currently being sold in only 8,000 outlets. The HP partnership should dramatically increase the iPod's addressable market," he said.

Apple stock closed at $22.72 at close of trade Friday, following a week in which its stock value eroded slightly – despite impressive Q1 results. Analysts believe this reflects profit-taking by investors.