Slowing Apple services is a potential concern for margin-focused investors

Apple CEO Tim Cook speaks at the Apple Worldwide Developers Conference (WWDC) at the San Jose Convention Center in San Jose, California on Monday, June 4, 2018.

Josh Adelson | AFP | Getty Images

For more than half a decade, Apple has been touting its services business as an engine of growth that will offset the saturation of smartphones and provide better profits for investors.

This story may lose some of its power.

In its quarterly earnings report on Thursday, Apple beat out the net profit. But the services business was a weak spot in a better-than-expected report. The unit grew 12 percent from the previous year to $19.6 billion, missing the average analyst estimate of $19.7 billion, according to Refinitiv.

It was also the slowest growth rate since the last quarter of 2015 for the services unit, which includes Apple Music, iCloud Storage, App Store revenue, Apple Pay, and warranties. It doesn’t look like the current quarter will be any better. Apple Chief Financial Officer Luca Maestri said that in the September period, the services business will grow by less than 12% due to macroeconomic conditions and a strong US dollar.

Apple shares rose in extended trading Thursday on the back of strong iPhone and iPad sales, which beat estimates. But Wall Street has reason to worry based on the slowdown in services, which posted growth of 27% in fiscal 2021 and 16% in 2020, the first year of the pandemic.

Investors generally like Apple’s move to services, because products are more profitable than devices and often bring in recurring revenue. The unit had gross margin, or residual profit after accounting for cost of goods sold, of 71.5% last quarter, compared to Apple’s gross margin of 43.3%.

Morgan Stanley analysts wrote earlier this month that Apple’s long-term valuation could rise by 30% if the company focuses on making money from its existing customers with expanded services.

“We believe Apple stock underestimates the value of Apple’s user life,” Morgan Stanley analyst Erik Woodring wrote, citing services growth as a major investment driver.

Maestri said that the performance of the services business is in line with his expectations. And even with growth slowing to 12%, it’s still seeing stronger expansion than the company as a whole, which grew by 2%.

Apple CEO Tim Cook said the services division was affected by the economic situation. In particular, he cited the company’s advertising business, which is one of the youngest.

“It is clear that digital advertising has been affected by the macroeconomic environment,” Cook said. “It’s a mixed bag in terms of what we think we’ve seen.”

Maestri said the Covid-19 shutdowns may have made services growth “lumpy,” which led to difficult year-over-year comparisons.

“There have been closings, reopenings and so on,” Maestri said. “So it’s very difficult to talk about a steady state growth rate for our services business.”

Maestri said the number of iPhone users is still growing, indicating that the services business can continue to expand by attracting new customers. He added that music, cloud services, AppleCare warranties and payments all hit record revenue levels during the quarter.

The company hasn’t said anything about licensing fees, like Google’s payments to Apple to be the default search engine for the iPhone, or App Store revenue. Analysts say these are among the largest components of services.

Watch: Tim Cook is the best operator in the technology sector

#Slowing #Apple #services #potential #concern #marginfocused #investors

Leave a Comment

Your email address will not be published.