January 29, 2019 / 10:35 PM / in 6 months

Breakingviews - Apple cash and services salve iPhone worries

A customer compares the size of the new iPhone XS and iPhone XS Max at the Apple Store in Singapore September 21, 2018. REUTERS/Edgar Su

NEW YORK (Reuters Breakingviews) - Apple’s cash and services help salve iPhone worries. The $740 billion tech giant’s holiday quarter was dismal, as foretold. A 5 percent sales drop shows Tim Cook’s company can no longer expect to sell significantly more phones or jack up prices. Rising margins on extras sold to iPhone users and the promise of $130 billion of capital returns buys Apple time to refresh.

The iPhone has transformed Apple over the past dozen years, providing about 60 percent of revenue, but the smartphone market has matured. The number of units sold worldwide should grow less than 3 percent this year, estimates research outfit IDC.

Apple had resisted the trend by raising prices to sustain profit growth, but that game appears to be up. Revenue from the iPhone fell nearly 15 percent in the latest quarter from a year earlier even though the company charges prices almost 5 times as high as the average non-Apple smartphone, according to Sanford Bernstein. Apple pinned the latest sales slowdown predominantly on China, but it’s more likely that was simply the first market where sticker shock hit hard.

A fast-growing services business provides some solace. Revenue from its app store, payments, online storage and the like accounted for 13 percent of all sales. Moreover, the margins are hefty at 63 percent, up nearly 5 percentage points from the same period last year. Both of these trends should continue as Apple sells more goods to users, and use its scale to reap a larger chunk of profit.

Yet investors appear skeptical that services can offset stalling hardware sales. Apple’s stock has fallen by nearly a third since its October peak, erasing some $360 billion in market cap – more than all but the six most-valuable U.S. companies. The shares trade at just 12.5 times estimated earnings over the next 12 months, according to I/B/E/S data from Refinitiv, compared with around 22 times for Google parent Alphabet and Microsoft.

Turning that valuation around will require evidence that Apple is making progress in new areas. Health initiatives such as using its devices to detect heart anomalies and advances in augmented reality are promising, but will take time to deliver. Apple’s cash provides breathing room. It returned $13.1 billion to investors in the latest quarter, below its recent average, but its plan to eliminate that cash pile means plenty of buybacks ahead. That helps, but Apple needs to cook up new gadgets.

Breakingviews

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