One of the most bullish takeaways from an exceptional fiscal second-quarter earnings report from Apple Inc. (Nasdaq: AAPL) earlier this month was a surprise uptick in the company’s services segment revenue growth. Analysts say services revenue can pick up the slack as the iPhone market cools over time, but investors need to make sure they are keeping expectations in check.
Apple Services, which includes the App Store, iTunes, Apple Music, Apple Pay, AppleCare, iCloud, licensing and other software services, accounted for $9.2 billion in revenue in the most recent quarter. The headline number represented 31 percent year-over-year growth, a sharp increase from the 13 percent growth Apple reported in the fiscal first quarter.
[See: 7 of the Best Stocks to Buy for 2018.]
However, Bernstein analyst Toni Sacconaghi says the past two quarters of services growth are a bit skewed and potentially deceptive due to one-time items. Once Sacconaghi adjusted for these one-time items, he estimates services revenue was up 24 percent in the first quarter and 27 percent in the second quarter.
That 3 percent quarterly increase may not seem as bullish as the 18 percent increase Apple reported, but Sacconaghi says the important thing for investors is that services revenue growth is clearly gaining steam. Adjusted Services revenue growth was a combined 24 percent in the first half of fiscal 2018 compared to just 18 percent in the first half of fiscal 2017.
For investors wondering where all this services growth is coming from, Sacconaghi says Alphabet ( GOOG, GOOGL) subsidiary Google has been a cash cow for Apple.
“Our analysis suggests that licensing (primarily [traffic acquisition cost] payments from Google) may have accounted for essentially all of services’ 600-basis point acceleration in growth,” Sacconaghi says.
Bernstein estimates Google will make between $4 billion and $5 billion in TAC payments to Apple in 2018.
Looking ahead, Sacconaghi says services growth will likely decelerate in the second half of the fiscal year as the segment starts to run into difficult year-over-year comparisons. Still, Sacconaghi says investors should be optimistic about the services segment as long as they don’t expect too much.
“While we still doubt that services can sustainably grow at 20 percent-plus without new services offerings, we now see Apple as likely to hit its bogey of doubling services to $49 billion by the end of [fiscal 2020],” he says.
[See: 9 Mature Tech Stocks to Buy for Dividends.]
Bernstein has a “market-perform” rating and $190 price target for AAPL stock.
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Apple Services Pace Draws Doubts originally appeared on usnews.com
