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One of the strong points of Apple Inc.’s (NASDAQ:AAPL) second-quarter earnings was its Services division. Once again, Apple Services revenue was up, this time by 31% year-over-year. However, a closer look reveals some challenges on the horizon if services like Apple Music and the App Store are going to help take the pressure off iPhone sales in driving future AAPL stock growth.
CEO Tim Cook had this to say about his company’s stronger-than-expected performance: “We’re thrilled to report our best March quarter ever, with strong revenue growth in iPhone, Services and Wearables.”
That Apple Services revenue is worth spiking out. It increased 31% year-over-year. Services is the second-largest division in AAPL, with nearly $9.2 billion revenue for the quarter –more than double what the company made selling iPads. We’ve been pointing out for more than a year that as the smartphone market matures and iPhone sales level out, Apple Services revenue is increasingly important to the bottom line –and to the performance of AAPL stock.
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Source: Statista
Services like the App Store, Apple Music, AppleCare, Apple Pay and iCloud storage provide ongoing revenue based on AAPL’s existing pool of iPhone, iPad and Mac users. The revenue isn’t cyclical and doesn’t require convincing someone to buy a $999 iPhone X. And the sustained growth of that Apple Services revenue shows the potential for it to help keep investors on board as the iPhone mad money begins to dry up.
But as pointed out by Reuters’ Stephen Nellis, there are challenges facing this division.
Services Revenue Does Not Guarantee Profit Margins
One of the reasons the iPhone has pushed AAPL stock so high isn’t just the revenue from iPhone sales, it’s the profit margins the company makes on these smartphones. The iPhone X is estimated to have a profit margin of over 60%. Company wide, Apple reported margins of 38.3%. But within the Services division, the margin levels are mixed and likely lower than that average.
For example, the App Store is considered a higher margin source of Apple Services revenue. AAPL collects 30% of the price of apps and 15% of App Store subscriptions that extend beyond one year. That’s well below the 38.3% average. While iCloud storage likely has margins that are considerably higher than that average, Apple Music likely makes much less. Reuters points out that Apple Music’s primary streaming music competitor Spotify Technology SA (NYSE:SPOT) reported 20% margins for 2017.