- This is the fifth article in our Apple earnings preview series. Today, we talk about a segment that, in my view, gets less attention than it deserves: services.
- Services can be credited, in part, for Apple stock (AAPL) – Get Free Report valuations having skyrocketed in the past years. But now, the segment is experiencing sharply decelerating growth.
- AAPL investors can follow the company’s fiscal Q1 earnings event on this channel in real-time, via live blog, on February 2, starting at the closing bell.
(Read more from the Apple Maven: Apple Stock: Will The Mac Save The Day In Fiscal Q1?)
Apple’s Services: Q1 May Be The Worst Ever
Apple’s fiscal Q1 should be uninspiring across the board – with the likely exception of the iPad business, for reasons that I discussed in detail not long ago. And while the iPhone and Mac will probably witness YOY sales contraction, the segment that worries me the most is services.
CFO Luca Maestri himself projected some sort of positive growth in the services business, but likely at a much smaller rate than investors have become accustomed to seeing. According to him, in the most recent earnings call:
“Specifically on Services, we expect to grow but to be impacted by the macroeconomic environment increasingly affecting foreign exchange, digital advertising and gaming.”
Of the factors listed above, FX is likely to be less of a headwind than originally anticipated. The US dollar has been weakening agains a basket of foreign currencies since the day that Apple shared its fiscal Q1 outlook – something to the tune of 8%.
Otherwise, services should, indeed, take a hit from squeezed advertising budgets and a likely pullback in gaming-related consumer spending (the latter impacts the App Store, which is probably the most significant driver of revenues within services).
Take all the above into consideration, and Apple’s services segment could have its worst quarter of performance in a long time, maybe ever. The graph below shows the sharp decline in growth rates witnessed since mid-2021, when the COVID-19 tailwinds reached a peak.
This time, I would not be surprised to see segment revenue growth reach the low-single digits and even converge towards zero, especially against stacked comps of 24% in both fiscal Q1 of 2022 and 2021 that were historically very high.
(Read more from the Apple Maven: Apple Stock: iPhone Sales May Surprise In Fiscal Q1)
Why Worry About Apple’s Services Segment?
Considering how iPhone (52% of total company sales in fiscal 2022) and Mac revenues could easily drop by 10% YOY or more this time, why is positive (even if modest) growth in services something to worry about?
One of the benefits of having a thriving services business is that revenues tend to be stabler and more predictable. This is the case because of repeat purchases and subscriptions by consumers that are already Apple customers.
In addition, services tend to carry wide margins – about twice as large as product margins. The combination of steady revenues and rich operating profits contributes greatly to reduce investment risk. That is to say: Apple’s services help to keep the stock richly valued.
The graph below, provided by Stock Rover, illustrates the point. Notice how Apple stock’s trailing P/E has climbed substantially from around 10x to 23x over the past decade.
Back in 2013, services, which used to be lumped together with iTunes and software, accounted for only 9% of Apple’s total revenues. In fiscal 2022, it represented 20% of sales and about one-third of total operating profits.
(Read more from the Apple Maven: Apple’s Q1 Earnings: This Should Be The Bright Spot)
Apple Stock Needs A Strong Services Segment
For AAPL to find its way north once again, I believe that a recovering services business will be crucial. While better-than-expected FX headwinds could be a positive in fiscal Q1, I doubt that the results and narrative will improve substantially already in the 2022 holiday period.
That said, and despite the challenges faced by the global economies in 2023, I hope that a more upbeat outlook will be communicated on Apple’s earnings day, February 2. A quick rebound in service segment revenues is likely to be a meaningful bullish development.
Ask Twitter
We have recently asked Twitter, about Apple’s fiscal Q1 earnings report that is scheduled to be released on February 2: “which segment do you think will perform best relative to expectations?” You can still participate and share your opinion.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting the Apple Maven)