Trifecta: Stable Device Base, Growing Services, and Buybacks

Trifecta: Stable Device Base, Growing Services, and Buybacks

  • Shares of AAPL were up ~4% in the aftermarket because investors had been expecting below-consensus guidance, but the company guided in line to slight upside for the Jun-18 quarter. (revenue guidance of $51.5-$53.5B vs. the Street at $51.5B)
  • The iPhone business is becoming increasingly predictable, which should ease quarterly investor anxiety.
  • The Services business is building muscle, up 31% y/y vs. 18% y/y in Dec-17.
  • While the capital return update of $100B was in line with expectations, the theme of capital return will play a greater role in the future Apple story.

Conclusion: The Apple story is intact. Near-term, investor optimism will rise going into the summer as anticipation grows ahead of 3 new iPhones in the fall. Long-term, Apple’s loyal active base of ~800m iPhones should yield a predictable 215-225m in annual iPhone unit sales that will drive Services growth of 13-15%. Allocation for share repurchases should increase annually, and lastly, the company is a safe haven in terms of protecting user privacy.

We’ve entered a period of greater visibility in the iPhone business.

  • iPhone stability. Implied in the Jun-18 guidance is ~2% iPhone unit growth, which compares to 3% in Dec-17 and -1% in Sep-17. This suggests that the iPhone business is becoming more stable, albeit at a lower growth rate. While investors will always have some anxiety regarding the quarterly iPhone number, the results and guidance suggest we’ve entered a period of greater visibility in the iPhone business.We expect the iPhone to be flat to up 5% per year over the next 4 four years.
  • Service’s growing and stable. Another aspect of improved visibility to the Apple story is Services, which were up 31% compared to 18% growth in Dec-17. The company now has 270M subscriptions, up from 240M last quarter. We believe the Services segment will grow between 13% and 20% per year over the next five years driven by continued growth in existing services along with new, innovative services.
  • Capital returns rising tide. The company announced a $100B capital return target (in line with Street thinking), but, for the first time, did not give a timeline. While the update to the capital return program is not impacting AAPL shares in the aftermarket, we believe buybacks will play a central role in investor thinking around the Apple story over the next 5+ years. Apple will generate between $40B – $60B in annual free cash flow that will effectively be given back to investors with the majority (85%+) allocated to buybacks. Buybacks could increase earnings and share price by 2-5% in each of the next several years. If Apple shares were to gain a valuation closer to other FANG stocks, the company would likely slow its buyback and increase its dividend. The fact that CFO Luca Maestri indicated that buybacks will be the focus of the capital return is a sign that Apple sees its share price as undervalued in the near term.

Other notable takeaways:

  • China. China revenue grew 21% in Mar-18, compared to 11% in Dec-17. Tim Cook mentioned four reasons for the strength in China including, Services, wearables, iPhone, and Mac. We believe the iPhone X was the clear driver in China given our observation that Chinese consumers tend to upgrade at a higher rate when there is a more measurable change in the iPhone form factor (as with iPhone X). This is the first time since 2014 that we’ve seen a meaningful change in the hardware design.
  • Apple Watch. We estimate Apple Watch accounts for about 3% of Apple’s overall business, but it is growing at close to 50% y/y compared to the iPhone at 3% growth. After Apple Watch debuted with disappointing results, the product has slowly climbed into favor with consumers as the theme of wearables becomes more mainstream. Note that the company does not report Apple Watch results, but did mention the wearables category, which includes Apple Watch, AirPods, and Beats headphones, was up 50% y/y. Since the Beats business is still likely flat to down, we think it’s a safe assumption that the Watch grew as fast as the overall wearables business.
  • See our Apple model here.

Disclaimer: We actively write about the themes in which we invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.