Apple services slowdown in Q3 could cause investor concern

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 Edelson | AFP | Getty Images

For more than half a century, Apple advertises his business services as a growth engine that offsets smartphone saturation and delivers healthier returns for investors.

This story may lose some of its power.

In his quarterly income statement on Thursday, Apple beat the top and bottom lines. But the service sector was the weak spot in the report, which was otherwise better than expected. The division grew 12% year-over-year to $19.6 billion, according to Refinitiv data, below analysts’ median estimate of $19.7 billion.

It was also the slowest growth rate since Q4 2015 for the services division, which includes Apple Music, iCloud storage, App Store revenue, Apple Pay and warranties. The current quarter looks no better. Apple CFO Luca Maestri said the services business will grow by less than 12% during the September period due to macro conditions and a strong US dollar.

Apple shares rose in extended trading on Thursday. sales force iPhone and iPadwhich exceeded the estimates. But Wall Street has cause to worry about a 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 products are more profitable than hardware and often generate consistent income. The division had a gross margin, or profit left after cost of goods sold, of 71.5% in the most recent quarter, compared to Apple’s overall gross margin of 43.3%.

Morgan Stanley Earlier this month, analysts wrote that Apple’s long-term valuation could rise by 30% if the company focuses on profiting from its current customers through expanding services.

“We believe Apple shares underestimate the lifetime value of an Apple user,” wrote Morgan Stanley analyst Eric Woodring, citing growth in services as a key investment driver.

Maestri said the services business was performing in line with his expectations. And even as growth slowed to 12%, it still posted stronger growth 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 mentioned the company’s advertising business, which is one of the smaller services.

“The macro environment has clearly affected digital advertising,” Cook said. “It’s a mixed bag in terms of what we think we’ve seen.”

The shutdown due to Covid-19 may also have made service growth “uneven,” Maestri said, making it difficult to compare to last year.

“There have been lockdowns, reopenings and so on,” Maestri said. “Therefore, it is very difficult to talk about a sustainable growth rate for our services business.”

Maestri said the number of iPhone users is still growing, suggesting that the services business could continue to expand by attracting new customers. He added that music, cloud services, AppleCare guarantees and payments hit all-time highs in revenue during the quarter.

The company did not say anything about license fees such as payments Google makes to Apple be the iPhone’s default search engine or App Store revenue. Analysts say these are among the largest components of the service.

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