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Apple Could Rise 10% in 6 Months
As high-margin services grow, Apple could earn a higher valuation. And shares could hit $155 on iPhone.
March 18, 2017
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By 2020 Apple’s service revenue could approach $50 billion. Apple Park, in Cupertino, Calif., above, will become the company’s new headquarters. Noah Berger/REUTERS
Apple was low-hanging fruit when Barron’s recommended the stock last spring at $108 (“Why Apple Is Worth $150 a Share,” April 9). It recently fetched $140, for a return since our story of 32%, including dividends. That compares with 19% for the Standard & Poor’s 500 index.
Don’t sell yet. Wait at least until the end of summer—apple-harvesting season in our home state of New York—when buzz for the coming 10-year anniversary iPhone is likely to hit a peak. Apple shares (ticker: AAPL) could return another 10% by then.
While rumors swirl around Apple’s planned devices, the company’s high-margin services revenue probably will continue to race quietly higher. As we wrote a year ago, services are a key to smoothing out Apple’s earnings swings and garnering its shares a handsomer valuation.
So far, the stock’s rally has hinged on two factors. The first is that Apple traded at just 12 times earnings at the time of our latest story, a 35% discount to the broad market, and a valuation befitting a troubled concern. That’s not including cash and investments, worth $38 a share at the time. Second, a string of quarterly reports showed that the company isn’t troubled.
For one thing, iPhones, which bring in about two-thirds of revenue, show little sign of falling out of favor. Unit sales dropped 8% in the fiscal year that ended last September, but only because the prior fiscal year saw the mother of all upgrade cycles, when Apple rolled out its first big-screen phones, meeting pent-up demand.
This fiscal year, iPhone units are expected to grow 4%, and next year they’re seen rising 8% to a new record. Beyond a performance bump, the next phone could get a glass body, a supercrisp, edge-to-edge display without a physical home button, and wireless charging, if rumor Websites are to be believed.
We’ll see. Meanwhile, services have brought in $25.5 billion in the past year, or more than 12% of revenue. Apple now makes more from services than from Mac computers. In the latest fiscal year, services revenue surged 22%, in part because Apple’s iPhone upgrade program cleverly packages an AppleCare service plan into the monthly installment payments.
AppleCare and related services now bring in 1.9% of total revenue, estimates Amit Daryanani, who covers Apple for RBC Capital. Other big contributors are iTunes, including movie rentals, and Apple Music, a streaming service, which combined deliver 2.5% of revenue; iCloud, Apple Pay, iAd, and such, which bring in 2.7%; and the app store—“the world’s greatest toll booth,” according to Daryanani—at 3.9% of revenue.
By fiscal 2020, Apple’s service revenue could approach $50 billion, and it comes with gross profit margins of 60% or so. That’s more than 20 points higher than the rest of the business. It is one reason Apple’s earnings per share, $8.31 in the latest fiscal year, could reach $11 in three years.
Daryanani reckons that swelling annuity makes the stock worth 17 times forward earnings, closer to where software and services companies like Microsoft (MSFT) and Alphabet (GOOGL) trade. Apple is trading below 15 times forward earnings. Cash and investments have grown to $46 a share. Last Tuesday, Daryanani bumped his price target to $155 from $140.
For another sign that Apple is still a good value, look to Omaha. Berkshire Hathaway (BRK.A) has increased its stake to over 130 million shares from 10 million a year ago, becoming a top-five shareholder. In a television interview, Warren Buffett called the iPhone “a sticky product” and “enormously useful.” The stickiness goes hand-in-hand with services. The iPhone user with years of family photos in Apple’s ecosystem might not only be loathe to switch phones, but also more willing to pay monthly for cloud storage once his phone’s drive is filled up. Apple isn’t the fastest-growing tech firm around—but it sure is peppy for a utility.
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