Apple’s services slowdown is a potential concern for profit margin-focused investors


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

Josh Edelson | AFP | Getty Images

For more than half a decade, Apple has been promoting its services business as a growth engine that will offset smartphone saturation and deliver healthier returns for investors.

That story might lose some of its power.

In Thursday’s quarterly report, Apple beat both the top and bottom lines. But the services sector was a weakness in an otherwise better-than-expected report. The unit grew 12% from a year earlier to $19.6 billion, lagging the average analyst estimate of $19.7 billion, Refinitiv said.

It was also the lowest growth rate since the fourth quarter of 2015 for the service unit, which includes Apple Music, iCloud storage, App Store revenue, Apple Pay and warranties. The current quarter is not looking any better. Apple CFO Luca Maestri said its services business would grow by less than 12% in the September period due to macroeconomic conditions and a strong US dollar.

Apple shares rose during extended trading Thursday on the back of sales of iPhones and iPads, which exceeded estimates. But Wall Street has raised concerns based on the slowdown in services, which grew 27% in fiscal 2021 and 16% in 2020, the first year of the pandemic.

Investors generally like Apple’s move to services because its products are more profitable than hardware and often generate recurring revenues. The device had a gross margin, or profit after taking into account the cost of goods sold, of 71.5% in the last quarter, compared to Apple’s total gross margin of 43.3%.

Morgan Stanley analysts wrote earlier this month that Apple’s long-term valuation could rise 30% if the company focused on monetizing its current customers through expanded services.

“We believe Apple stock undervalues ​​an Apple user’s lifetime value,” wrote Morgan Stanley analyst Erik Woodring, citing growth in services as a key driver of investment.

Maestri said the services company performed in line with expectations. And even with growth slowing to 12%, it still saw more vigorous expansion than the company as a whole, which grew 2%.

Apple CEO Tim Cook said the services division was hit by the economic situation. He specifically mentioned the company’s advertising business, one of its smaller services.

“Digital advertising was clearly influenced by the macroeconomic environment,” Cook said. “It’s a mixed bag in terms of what we think we’ve seen.”

Covid-19 stops may also have made services growth “lumpy”, leading to difficult year-over-year comparisons, Maestri said.

“There have been closures and reopenings and so on,” Maestri said. “So it’s very difficult to talk about a stable growth rate for our service sector.”

Maestri said the number of iPhone users is still growing, suggesting that the service sector can continue to grow by bringing in new customers. He added that music, cloud services, AppleCare guarantees and payments all hit record revenue levels during the quarter.

The company didn’t say anything about licensing fees, such as the payments Google makes to Apple to become the iPhone’s default search engine, or the revenue from the App Store. According to analysts, these are among the largest service components.

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