Apple Inc. reported a strong Q3. But, there's more good news for Apple stock investors over and above the headline numbers.
Cupertino, California based Apple Inc (NASDAQ:AAPL) announced its latest quarterly earnings last week. The numbers were stronger than expectations across the board, which saw Apple Bulls cheering the stock to fresh all-time highs. Apple reported an EPS of $1.67, good for a 10 cent beat, and revenue of $45.4 billion, $510 million higher than the analyst consensus. However, there was more encouraging news below the surface, which could easily have been missed in the excitement of the earnings/revenue beats. More specifically, we are talking about Apple's services segment, and one particular sub-segment, which could emerge as the next major catalyst for Apple earnings. App store revenue, which includes revenue from app downloads was the major driver of the services segment.
A Strong Quarter For Apple Services.
The performance of Apple's services segment in Q3 deserves a mention before we dive into more details. The segment posted a record quarter, generating revenue of $7.27 billion, up 22% year-over-year, an acceleration from the 1HFY2017 growth of 18% YoY. The segment posted sequential growth in Q3 for only the second time in the last 4 years, which highlights the strength the segment has been registering, benefitting from a strong quarter for App Store, which includes revenues from app downloads across the iOS ecosystem. And impressively, this growth is broad based. As Tim Cook stated on the Q3 conference call, the segment continues to "see great performance all around the world, with double-digit growth in each of our geographic segments." The segment revenues are now equal to those of a Fortune 100 company, a goal Apple had aimed to reach by the end of FY2017. Apple's services segment generated revenue of $27.8 billion over the last twelve months (LTM). To put things in perspective, consider this: Facebook's entire business generated revenue of $27.64 billion in the same timeframe. In other words, Apple's services segment is now a bigger revenue engine than all of Facebook combined.
The Catalyst At The Heart Of This Growth.
In the context of the strong growth reported by the services segment, it's important for investors to identify the catalyst powering this growth. According to the Apple 10-Q SEC filing, the services segment "Includes revenue from Internet Services, AppleCare®, Apple Pay, licensing and other services." So which of these exactly was responsible for the spurt in services revenue? Apple's 10-Q has an answer and so does Luca Maestri, the CFO of Apple. According to the latest 10-Q, "The increase in Services net sales in the third quarter and first nine months of 2017 compared to the same periods in 2016 was due primarily to growth from the App Store and licensing sales." In addition to this, Luca stated on the Q3 con-call that "The App Store was a major driver of this performance." He went on to add, "And according to App Annie's latest report, it continues to be by a wide margin the preferred destination for customer purchases, generating nearly twice the revenue of Google Play." The App Store revenue includes revenue from the millions of app downloads on Apple's iOS ecosystem. But, why exactly is this important?
As we have covered in the past, the services segment will account for a significant share of overall profits, 25% of FY 2017 profits to be precise. While the entire services segment is a high margin business, App Store revenue is the best of them all. Gross margins on App Store revenues are somewhere between 90% to 95%, according to former Piper Jaffray analyst and long term Apple bull, Gene Munster. Given this high margin profile, App Store revenue driving the overall revenue growth of Apple services is a big positive for Apple stock and its investors. Apple services accounted for nearly 16% of Apple revenue in Q3 and given the rapid growth of App Store revenues, it wasn't surprising that Apple's 18% YoY EPS was the highest rate of EPS growth since Q4 2015. The services segment, and App Store (app downloads revenues) in particular, could be the next major catalyst of Apple Earnings.
Apple Stock Is Again The Wall Street Darling.
Following the strong Q3 showing, Wall Street analysts have been busy boosting their Apple stock price targets. RBC's Amit Daryanani, JPMorgan's Rod Hall and Piper Jaffray's Michael Olsen, all issued fresh bullish commentary this week, with price targets ranging from $176 to $190, implying a 13% upside from the last closing price, at the lower end. The Wall Street consensus price target is up to $166.65 from $160 a week ago. The optimism on Wall Street is in alignment with our take on the stock, which is reflected in our Apple stock analysis. Apple stock is also a part of our top stock picks from the technology sector, which have outperformed the NASDAQ by 135%.
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