Apple earnings show growing immunity to smartphone's sales slowdown

The numbers show that Cook's strategy of selling a growing array of services through a The numbers show that Cook's strategy of selling a growing base of more than 1.3 billion Apple devices is working

Apple Inc.’s results confirmed that, while the days of double-digit smartphone industry growth are over, Chief Executive Officer Tim Cook has a plan to withstand the slowdown.

The shares gained in late trading Tuesday after the company reported iPhone sales in line with analysts’ expectations, gave a bullish revenue forecast and highlighted a surging services business. A new $100 billion stock repurchase plan and higher dividend also helped.

The numbers show that Cook’s strategy of selling a growing array of services through a base of more than 1.3 billion Apple devices is working. The smartphone sector saw shipments fall 2 per cent in the past year, according to Strategy Analytics, so the company must evolve beyond its reliance on a device that still accounts for more than 60 per cent of revenue.

“Slowly but surely, [Apple] is morphing into more than just an iPhone story and is displaying ability to sustain revenue growth irrespective of iPhone trajectory,” Amit Daryanani, an analyst at RBC Capital Markets, wrote in a research note.

The company reported iPhone unit sales grew just 2.9 per cent in the fiscal second quarter. While the flagship iPhone X may not have matched the hype from its launch late last year, the device’s $999 starting price helped boost phone revenue growth 14 per cent.

Cheaper iPhone models for emerging markets, and wearable gadgets like the Apple Watch, also drove revenue growth.

"Growth in the near-term will come from higher iPhone X pricing, a lower-cost iPhone SE update, selling more services like Pay to its premium subscribers, and increasing output of its surprisingly popular Watch portfolio," said Neil Mawston, an analyst at Strategy Analytics.

Revenue from services surged 31 per cent to a record $9.2 billion in the quarter. The App Store, Apple Music, iCloud storage and Apple Pay all generated record sales, Cook said. The company is expanding these offerings with original videos and a news subscription service.

As long as Apple continues to sell around the same number of devices each year -- 217 million iPhones, more than 40 million iPads, and almost 20 million Macs in fiscal 2017 -- it can sell users of these devices a growing list of services that integrate tightly with the hardware.

"You have to start thinking about Apple differently going forward," Dan Morgan, senior portfolio manager at Synovus Trust Company, wrote in a recent note. "Apple can support the stock as the investment thesis evolves from one of product cycle to services-led growth."

An Apple Music subscription costs $10 per month (unless they’re on a family plan), and the number of paying users recently hit 40 million. The middle tier for iCloud storage costs $2.99 a month. The company now has 270 million paid subscribers across applications and its own services, up by 100 million from the same period a year ago.

Cook suggested new services are in the works and that Apple’s installed base of devices grew by double digits from a year earlier. "This is just a huge opportunity for us and we feel very good about the track that we’re on," he said.

Thanks to this new stream of recurring revenue, the health of the smartphone industry is becoming less relevant to Apple. Several iPhone suppliers and manufacturers reported disappointing results in recent weeks, sparking concern that Apple’s numbers would be weak. But these companies don’t gain from Apple’s expanding services offerings.

Some Asia suppliers did rally after Apple’s report, with South Korea’s LG Innotek Co. up as much as 7.3 per cent. But the reaction was muted for most partners given the limited growth in iPhone sales.

Synovus’s Morgan recently estimated that services will drive about 60 per cent of Apple’s revenue growth over the next five years. That’s a big change from the previous half decade when 86 percent of the company’s growth came from iPhone sales.

"The Services segment will grow between 13 per cent and 20 per cent per year over the next five years driven by continued growth in existing services along with new, innovative services," Gene Munster, co-founder of Loup Ventures and a veteran Apple analyst, wrote in an email following the results on Tuesday.

Cook hinted at additional sources of growth in terms of both geographical areas and product categories. He said India is an attractive new market for iPhones, similar to China several years ago.

"There’s obviously huge opportunities there for us and we have extremely low share in that market overall and so we’re putting a lot of energy there," Cook said on Tuesday’s call with analysts.

Still, he rejected the idea that the smartphone market has become saturated. There were still a half a billion feature phones sold in the world last year, he noted. "Over time, every phone sold will be a smartphone and so it seems to us that with that many feature phones being sold, that’s a pretty big opportunity," the CEO told analysts.

Cook also discussed additional opportunities in health care. "It’s an area of great interest where we think we can make a big difference," he said on the call. Apple has continued to add new health tracking features to the Apple Watch and ships its iPhones with an app to manage health data and records.