Sunday, May 27, 2018

Apple Services The Next Stock Driver?

Apple is a great company, no doubt. We saw analysts making a case that Services will catapult the valuation. We wanted to see for ourselves. Let's go through some simple math to see if Services is in fact the next big thing for Apple.

Let's Do The Math What Services Means To Apple

Services has been growing at about a 20-30% pace.

Here's the numbers.


PHONE
8 X
Fiscal 2017 2017 2018 2018
Cal 2017 2017 2017 2018

Jun Sept Dec Mar

Q3 Q4 Q1 Q2A
Services 7266 8501 8471 9190
Growth 21.6% 34.4% 18.1% 30.5%
2 Yr Gr 40.4% 58.8% 36.5% 48.0%
Est EBIT 3633 4250 4235 4595

Growth accelerated in the most recent quarter to 30.5%. We like to use the two-year run-rate which adds this year and last year's growth.

If we say the underlying two-year trend is 45%, or 22.5% each year then here's what we'd get on an annual basis for services.

Fisc 2019 2020
Cal 2018 2019

Dec Dec
Yr EBIT
19154
23378
Add'l
3514
4224
Tax Adj
2987
3590
per share
0.65
0.89
Value
$9.7
$13.4

We're assuming the EBIT margins for Services is 50%.  If so you get an extra $.65 in earnings this calendar year and an extra $.89 for calendar 2019.

Using a 15 multiple that would give you an extra $10 in stock value this year and another $13+ value next year. Total it adds over 10% to the valuation through 2019.

That would tell you that Services profits should be a meaningful driver to the overall company.

But It Hasn't Shown Through Yet

This deserves more work but the issue we have is that Services has already been growing ahead of the business but the higher margin hasn't shown through to the corporate margins.

Look at Apple's trends for corporate margins.


Jun Sept Dec Mar

Q3 Q4 Q1 Q2A
Fiscal 2017 2017 2018 2018
Cal 2017 2017 2017 2018
EBIT 10768 13120 26274 15894
Margin 23.7% 24.9% 29.7% 26.0%
bp chg -.14% -.16% -.06% -.67%

They've been consistently down.

Even with Services having much higher margins than the overall business and growing faster we haven't seen Apple's overall margins start to move up on a year-over-year basis. That tells you the rest of the business is dragging margins much lower offsetting the Services benefit.

So will Services start to be accretive to the overall valuation? That depends. Will the rest of the business continue to offset the Services margin benefit or will Services shine through?

We plan to speak to the company in June and will try to get further understanding of what it will take to have Services shine through to the bottom line.



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