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  • Writer's pictureGVA Research

David Garrity on CNBC Worldwide Exchange: AAPL, The Rise of Services

David Garrity breaks down Apple’s earnings report from CNBC.

No Smartphone “Super Cycle” Yet, But Operating Leverage Is Alive & Well At AAPL

Off a modest +3% year/year increase in iPhone shipments to 52.2mm, AAPL delivered better than expected revenues of $61.1bn (expectations $60.9bn), a +16% year/year gain and the strongest revenue growth in more than the past two years, and net income of $13.8bn, a +25% year/year rise, with EPS of $2.73 (expectations $2.64). The gains were driven by the iPhone average selling price increasing 11% year/year to $728, in part reflecting the benefit from the $1,000 iPhoneX price point, which served to increase iPhone revenues +14% year/year. This kind of operating leverage in which a low single digit unit volume increase can produce strong double digit profit growth factored strongly into the board’s decision to increase dividend distribution by +16% to $2.92/share annually and boost the stock repurchase program by a record $100bn.

Services Operations Accelerating Revenue & Profit Growth, With Prospects Robust

While iPhone performance was solid, AAPL’s services operations provided acceleration to top-line growth with a +31% year/year increase to $9.2bn. With its customers paying for more than 270mm subscriptions, up +33% year/year, it appears AAPL’s ambitions to build an additional high-margin business line have not only gained traction, but are serving to accelerate overall corporate financial performance.

With a current installed iPhone owner base of 1.3bn, bear in mind that relatively modest service penetration can still drive substantial results. For example, the Apple Music subscription service ($10/month) now has 40mm subscribers (3.1% penetration), a level sufficient to deliver annual revenues of $4.8bn. It is not hard to find other subscription services with the potential to reach material scale. For example, iCloud storage, a popular service given how large video files can be, costs $2.99/month for a mid-tier service plan. A 5% installed base penetration rate would deliver annual iCloud storage service revenues of $2.3bn. With AAPL management discussing the development of health information services, Services is an area where growth prospects are likely to be robust long term as AAPL looks for segment revenues to hit $50bn by 2021.

China Returns As Growth Market For AAPL As Other Regions Beckon

Worries that AAPL has fallen off the mark in China were allayed with March 2018 results as Greater China revenues of $13bn reflected +21% year/year growth, the largest increase in the past 10 quarters. While China is clearly a competitive market in which the company has lost share since 2015, the most recent quarter offers some indication that it is still a growth market for AAPL. Away from China, other large developing markets beckon as AAPL is concentrating on India where it is possible for mass deployment of lower-priced phones to occur. Meanwhile, with industry-wide feature phone shipments still over 500mm last year, there is continued opportunity for AAPL to gain share and increase its installed iPhone user base as the mobile phone market eventually shifts fully to smartphones.

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