Jefferies says Apple’s services margins will surpass expectations

CEO Tim Cook (L) and senior vice president of Internet Software and Services Eddy Cue of Apple speak as they walk after lunch during the Allen & Co. annual conference at the Sun Valley Resort on July 11, 2013 in Sun Valley, Idaho.

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CEO Tim Cook (L) and senior vice president of Internet Software and Services Eddy Cue of Apple speak as they walk after lunch during the Allen & Co. annual conference at the Sun Valley Resort on July 11, 2013 in Sun Valley, Idaho.

While cutting iPhone estimates for Apple’s fiscal 2019, Jefferies analysts says the company’s services margins will greatly surpass expectations.

This is a story Apple has been trying to tell as it aims to shift the focus from its flagship hardware product. Since Apple announced it would no longer break out iPhone unit sales during its fourth quarter 2018 call with analysts, investors have feared that iPhone sales will continue to slow as the market reaches saturation. The company has tried to assure investors that other areas of its business, including services, which includes offerings like Apple Music, iCloud storage and App Store downloads, would soon become key revenue contributors. Jefferies’ assessment buys into that theory.

While cutting iPhone unit sale estimates by 3 percent for fiscal year 2019, Jefferies analysts predict the gross margin on Apple services will be 60 to 66 percent over 5 years, compared to the 56 percent consensus estimate.

“We believe Apple intends to tell a compelling Services story when it discloses gross margin for the first time ever next earnings,” Jefferies wrote in the note published Wednesday. It estimates the App Store will have a 19 percent compound annual growth rate over 5 years to surpass $32 billion in fiscal year 2023, with an 80 percent growth margin. Apple Music is growing faster but with lower margins, the analysts wrote, and they expect 34 percent compound annual growth rate over 5 years with a gross margin of 19 percent.

“The setup resembles when AMZN first disclosed AWS margin back in ’15, a positive for that stock,” the analysts wrote, referring to Amazon‘s disclosure of its margins for its cloud division, Amazon Web Services.

Apple has already made clear it intends to push further into non-hardware revenue streams. The company has recently begun buying its own lineup of shows for what will reportedly be the company’s Netflix competitor. CNBC reported in October that Apple is planning to give away some of its original shows through the “TV” app that’s included with iPhones and iPads.

“The opportunity for investors is that these higher margin, higher growth software businesses deserve a higher multiple vs the lower margin, lower growth hardware business,” according to the note, which rated Apple a buy while cutting its price target from $265 a share to $225 a share. Jefferies estimates earnings per share will almost double by fiscal year 2023 to reach $22.19 per share.

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